List the component costs of capital in ascending order (all four of them). Justify your ranking with an explanation for each component cost.

Question

Quizplus · Accepted Answer

The Answer is For most firms, k_d(1 − T) < k_p < k_e < k_n. Debt has the lowest component cost for two reasons: the bondholders are protected by the bond contract, making debt the least risky source of funds, and the tax break the firm receives for borrowing funds lowers the effective cost. The cost of new preferred equity may approach the cost of retained earnings, but since preferred dividends must be paid before common dividends may be paid, and since the preferred shareholders have a higher claim against assets than the common shareholders in the case of bankruptcy, preferred equity is less risky, and therefore less costly, than retained earnings. New common equity will be the most expensive because it includes the cost of retained earnings as well as flotation costs for issuing new securities.

List the Component Costs of Capital in Ascending Order (All