Question

why is external common equity capital more expensive than internal common equity capital? group of answer choices all of these because internal is free, it has no cost since there is no need to attract investors to raise internal equity. because the cost of external must take into account flotation costs, internal does not. none of these actually, external equity is not more expensive than internal, they both have the same cost. because the capital asset pricing model is used to estimate the cost of internal and the dividend valuation model is used to estimate cost of external.

Answer 1

External common equity capital is generally more expensive than internal common equity capital due to the costs of attracting external investors and the higher risk premiums that external investors may demand.

Step-by-step explanation:

External common equity capital is generally more expensive than internal common equity capital for several reasons. First, internal equity is essentially free since there is no need to attract investors to raise internal equity. On the other hand, external equity requires companies to attract investors, which involves costs such as flotation costs (e.g., underwriting fees, legal fees) that increase the cost of external equity.

Additionally, external equity may also come with higher risk premiums compared to internal equity. Investors who provide external equity capital may require a higher return on their investment to compensate for the higher risk they perceive in investing in a particular company compared to investing in their own business.

Therefore, the cost of external common equity capital generally includes both the direct costs associated with attracting investors and the higher risk premium demanded by external investors.