Joe's Discount Club currently has a weighted average cost of capital of 12%.Joe's has been growing rapidly over the past several years,selling common stock in each year to finance its growth.However,due to difficult economic times this year,Joe's decides to cut its dividend and increase its retained earnings so that the common equity portion of its capital structure will include only retained earnings and no new common stock will be sold.Joe's weighted average cost of capital this year should be

Question

Quizplus · Accepted Answer

By retaining earnings instead of issuing new common stock, the cost of equity will decrease, leading to a lower overall weighted average cost of capital. Therefore, the weighted average cost of capital should be less than 12%. It cannot be zero since the cost of debt is still a factor in the calculation.

Joe's Discount Club Currently Has a Weighted Average Cost of Capital