Question

Smith Brothers has no retained earnings. The company uses the CAPM to calculate the cost of equity capital. The company's capital structure consists of common stock, preferred stock, and debt. Which of the following events will reduce the company's WACC?

a. The flotation costs associated with issuing new common stock increase.b. The company's beta increases.c. Expected inflation increases.d. The flotation costs associated with issuing preferred stock increase.e. The market risk premium declines.

Answer 1

If the market risk-premium declined, there will be a reduction in WACC. The correct answer is E

Step-by-step explanation:

The reduction in market risk premium reduces the cost of equity. If cost of equity declined, there will be a decrease in WACC. WACC is a function of each cost of capital and the proportion of source of finance in the capital structure.

Answer 2

Option e is correct

Step-by-step explanation:

Since market risk is equal to the difference between the company returns(retained earning )and the market risk free rate.