The cost of retained earnings is less than the cost of new common stock because
A) marginal tax brackets increase.
B) flotation costs are incurred when new stock is issued.
C) dividends are not tax deductible.
D) accounting rules allow a deduction when using retained earnings.

Question

Quizplus · Accepted Answer

Retained earnings are profits that are reinvested back into the company, and the cost of using these earnings is typically lower than the cost of issuing new common stock. This is because when new stock is issued, the company incurs flotation costs, such as fees for investment bankers, underwriters, and attorneys. These costs can be significant and can increase the overall cost of raising new equity capital. Additionally, dividends paid to shareholders are not tax deductible, which can raise the effective cost of using new common stock as a funding source.

The Cost of Retained Earnings Is Less Than the Cost