Question

Which of the following statements is correct?

a. The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.
b. The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.
c. There is an "opportunity cost" associated with using reinvested earnings, hence they are not "free."
d. The WACC as used in capital budgeting would be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.
e. The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital.

Answer 1

c. There is an "opportunity cost" associated with using reinvested earnings, hence they are not "free."

Step-by-step explanation:

When the reinvested earnings are invested that is basically the earnings associated with reinvestment would earn the same like that earned by the investment if not withdrawn and invested.

Let us say for example: Amount invested = $1,000

Return on such investment = $100

Now if such earnings are also reinvested then

Earnings = $110

Now if this $110 is used rather than investing again, then there is the opportunity cost of earning $11 on such reinvestment.

Thus, statement c is correct.