The reason why reinvested earnings have a cost equal to rs is because investors think they can (i.e., expect to) earn rs on investments with the same risk as the firm's common stock, and if the firm does not think that it can earn rs on the earnings that it retains, it should distribute those earnings to its investors. Thus, the cost of reinvested earnings is based on the opportunity cost principle.

Question

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The statement accurately describes the reason why reinvested earnings have a cost equal to rs, which is based on the opportunity cost principle. Investors expect to earn rs on investments with the same risk as the firm's common stock, and if the firm cannot earn rs on the earnings that it retains, it should distribute those earnings to investors. Therefore, the cost of reinvested earnings is the same as the cost of equity capital, which is represented by rs.

The Reason Why Reinvested Earnings Have a Cost Equal to Rs