Which of the following statements is most correct?
A) Because the cost of debt is lower than the cost of equity, value-maximizing firms maintain debt ratios of close to 100%.
B) Corporations that are 100% equity financed will have a much lower weighted average cost of capital because the lack of debt lowers their risk of bankruptcy.
C) The source of capital with the lowest after-tax cost is preferred stock, because it is a hybrid security, part debt and part equity.
D) The cost of a particular source of capital is equal to the investor's required rate of return after adjusting for the effects of both flotation costs and corporate taxes.

Question

Quizplus · Accepted Answer

The cost of capital is equal to the investor's required rate of return after adjusting for the effects of both flotation costs and corporate taxes. This means that the cost of a particular source of capital depends on the investor's required rate of return, as well as any costs associated with the issuance of that capital and the tax implications. Therefore, statement D is the most correct. Statements A, B, and C are not correct. Maintaining debt ratios close to 100% can increase bankruptcy risk, 100% equity financing may not always result in a lower weighted average cost of capital, and preferred stock is not necessarily the lowest-cost source of capital.

Which of the Following Statements Is Most Correct