Which of the following statements is correct?
A)Because we often need to make comparisons among firms that are in different income tax brackets, it is best to calculate the WACC on a before-tax basis.
B)If a firm has been suffering accounting losses and is expected to continue suffering such losses (and we then assume that its tax rate going forward is zero), it is possible that its after-tax component cost of preferred stock as used to calculate the WACC will be less than its after-tax component cost of debt.
C)Due to the way the MCC is constructed, the first break point in the MCC schedule must be associated with using up all available retained earnings and having to issue common stock.
D)Normally, the cost of external equity raised by issuing new common stock is above the cost of retained earnings.Moreover, the higher the growth rate relative to the dividend yield, the more the cost of external equity will exceed the cost of retained earnings.
E)None of the above is a correct statement.

Question

Quizplus · Accepted Answer

If a firm has no tax liability due to losses, the after-tax cost of preferred stock may be less than the after-tax cost of debt because preferred dividends are paid before taxes, resulting in a lower after-tax cost. A is incorrect because comparisons can be made after adjusting for the tax differences. C is incorrect because the first break point may be associated with issuing both common and preferred stock. D is incorrect because the cost of external equity is generally higher than the cost of retained earnings due to issuance costs and higher risk, regardless of growth rates.

Which of the Following Statements Is Correct