a. Since debt capital is riskier than equity capital, the after-tax cost of debt is always greater than the WACC.
b. Because of the risk of bankruptcy, the cost of debt capital is always higher than the cost of equity capital.
c. If a company assigns the same cost of capital to all of its projects regardless of the project’s risk, then it follows that the company will tend to reject some safe projects that it actually should accept and accept some risky projects that it should reject.
d. Because companies’ flotation costs are not required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.
e. Higher flotation costs tend to reduce the cost of equity capital.
This question was asked on Apr 30, 2010.
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