Question

Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost. True False

Answer 1

Answer:

False

Explanation:

Retained earnings have no flotation costs, but have opportunity costs. For example, if companies distribute the earnings to shareholders, shareholders can invest the funds in alternative sources for returns.

Answer 2

Answer:

False

Explanation:

Retained earnings as well as equity capital (raised through issuing stocks) have the same cost, and that is the required rate of return. Retained earnings must be treated as reinvested equity, since the alternative to retained earnings would be to distribute dividends to the stockholders.

Bonds usually have a lower cost and it is determined by the coupon rate and the corporate tax rate (interests paid lower taxes).