Question

For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.a. re > rs > WACC > rd.b. WACC > re > rs > rd.c. rd > re > rs > WACC.d. WACC > rd > rs > re.e. rs > re > rd > WACC.

Answer 1

Answer:

a. re > rs > WACC > rd.

Explanation:

Re represents cost of equity

Rs represents cost of retained earnings

WACC represents Weighted average cost of capital

Rd represents cost of debt

Basically the cost of equity is highest as there is no assured return on such equity investment.

Cost of retained earnings is less than cost of equity because amount invested is already in hands of company, although belonging to equity holders, thus is higher than total weighted cost of capital.

WACC is the cost after providing weights to every source of capital it is lower then equity, higher than debt because of average.

Cost of debt is lowest because of tax benefit from it.