Use the following statements to answer this question:
I.Without taxes, the benefit of having debt on the WACC largely vanishes.
II.Preferred shares cost the same as common equity financing.
A)I and II are correct.
B)I and II are incorrect.
C)I is correct and II is incorrect.
D)I is incorrect and II is correct.

Question

Quizplus · Accepted Answer

Statement I is correct because taxes provide a shield for interest payments on debt, making it a cheaper form of financing and lowering the overall cost of capital. Without this benefit, the weight of debt on the weighted average cost of capital (WACC) becomes negligible. Statement II is incorrect because preferred shares typically have a higher cost of financing compared to common equity, due to their fixed dividend payments and seniority in the event of liquidation.

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