Which of the following may be true of the cost of debt and cost of equity?
A) The weighted average cost of capital is computed by assigning weights to the cost of debt and the cost of equity of a firm.
B) The cost of debt for a firm is always equal to the cost of equity to the firm.
C) The cost of internally generated equity for a firm is greater than the cost of externally generated equity funds for the firm.
D) The cost of internally generated equity for a firm is less than the cost of debt for the firm.
E) The cost of externally generated equity is the sum of the cost of debt and the cost of retained earnings.

Question

Quizplus · Accepted Answer

The weighted average cost of capital is calculated by taking a weighted average of the cost of debt and the cost of equity based on the proportion of debt and equity in the company's capital structure. This means that both the cost of debt and the cost of equity are important inputs in the calculation of the WACC.

None of the other answer choices are true. The cost of debt and the cost of equity are two distinct concepts that are not always equal to each other (B), and the cost of internally generated equity is generally considered to be lower than the cost of externally generated equity (C) because there are no underwriting or flotation costs associated with issuing new stock. The cost of debt is usually lower than the cost of equity, so it is incorrect to state that the cost of equity is less than the cost of debt (D) or that the cost of externally generated equity is equal to the sum of debt and retained earnings (E).

Which of the Following May Be True of the Cost