Question

Match each of the following terms with their definition - Before-tax cost of debt - Cost of preferred stock - Cost of Common Stock - WACC A. The interest rate the firm must pay on new long-term borrowing B. the rate of return on retained earnings, and adjusted for flotation costs C. rate of return investors require based on the preferred stock dividend D. the average cost of raising new financing

Answer 1

Before-tax cost of debt ⇒ A. The interest rate the firm must pay on new long-term borrowing.

This refers to the interest rate that a firm will pay on long term borrowing as compensation to the lenders for lending the company some funds.

Cost of preferred stock ⇒ C. rate of return investors require based on the preferred stock dividend.

The cost of the preferred stock is the rate of the preferred dividend that investors require they are paid every year if dividends can be paid and sometimes even when it cannot.

Cost of Common Stock ⇒ B. the rate of return on retained earnings, and adjusted for flotation costs .

Commons stock costs is the required return on the retained earnings of a company.

WACC ⇒ D. the average cost of raising new financing.

Weighted Average Cost of Capital (WACC) represents the total cost of raising capital for the company as it incorporates the costs of debt, preferred stock and common stock.