Question

If a firm needs additional capital from equity sources once the retained earnings breakpoint is reached, it will have to raise the capital by issuing new common stock.a. True: Firms will raise all the equity they can from retained earnings before issuing new common stock, because capital from retained earnings is cheaper than capital raised from issuing new common stock.b. False: Firms raise capital from retained earnings only when they cannot issue new common stock due to market conditions outside of their control

Answer 1

Answer:

The correct answer is a. True.

Explanation:

Issuing new common stock helps a firm raise money. The capital is used to help the business grow, such as to acquire another company, pay debts or to have access to more cash for general corporate reasons.  

Therefore, firms will raise all the equity they can from retained earnings before issuing new common stock, because capital from retained earnings is cheaper than capital raised from issuing new common stock.      

Answer 2

Answer:

True: Firms will raise all the equity they can from retained earnings before issuing new common stock, because capital from retained earnings is cheaper than capital raised from issuing new common stock.

Explanation:

Firms have 2 equity sources, that is retained earnings and shares.

Retained earnings are the profit realised from business activities. Some part of it is paid as dividends to shareholders and the rest is pit back into the business.

When retained earnings are not enough for running of the business or theere is need of capital for expansion the business issues shares.

Shares are bought by stockholders in exchange for a stake in the company.

Note retained earnings are cheaper source of funds than shares. Retained earnings are profit from business and we will not need to pay for its use. However on shares dividends are paid to shareholders.

Retained earnings are the first choice for equity and then shares are issued for extra funds.