Question

Which of the following statements is CORRECT?a. We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company's WACC for capital budgeting purposes.b. The cost of new equity (re) could possibly be lower than the cost of reinvested earnings (rs) if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount.c. A firm's cost of reinvesting earnings is the rate of return stockholders require on a firm's common stock.d. The component cost of preferred stock is expressed as rp(1 − T), because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt.e. In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.

Answer 1

c. A firm's cost of reinvesting earnings is the rate of return stockholders require on a firm's common stock.

Step-by-step explanation:

Since a company aims for wealth maximization, it is not feasible to distribute all the earnings of the company to its shareholders.

Therefore, the earnings are then reinvested in order to earn more on such reinvestment.

When there is reinvestment the shareholders desire even more return as the earnings are not distributed. Accordingly the cost of reinvestment is the rate of return desired by the common stockholders on their shares.