For capital budgeting and cost of capital purposes, the firm should always consider reinvested earnings as the first source of capital⎯i.e., use these funds first⎯because reinvested earnings have no cost to the firm.

Question

Quizplus · Accepted Answer

Reinvested earnings have an opportunity cost to the firm because they forego the distribution of dividends to shareholders, which could be invested elsewhere. Therefore, the cost of equity capital should be considered when using reinvested earnings as a source of capital.

For Capital Budgeting and Cost of Capital Purposes, the Firm