Chapter 10, Problem 5Q

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

# The WACC is a weighted average of the costs of debt, preferred stock, and common equity. Would the WACC be different if the equity for the coming year came solely in the form of retained earnings versus some equity from the sale of new common stock? Would the calculated WACC depend in any way on the size of the capital budget? How might dividend policy affect the WACC?

Summary Introduction

To explain: If the WACC would be different or not if the upcoming year’s equity comes solely in the form of retained earnings rather than from the new common stock issue and based on the size of the capital budget and dividend policy.

Introduction:

Weighted Average Cost of Capital: It is the WACC (Weighted average cost of capital) of all the sources through which a firm finances its capital. It is the rate that a company will pay to all for raising finance. It can be termed as firm’s cost of capital. The company raises money through various sources such as common stock and preference share debt. The WACC is computed by taking the relative weight of each item of capital structure.

Explanation
• The WACC would be reduced if the coming yearās equity solely comes in the form of retained earnings rather than from the issue of new common stock.
• WACC depend upon the size of the capital budget. If there is high use of the retained earnings rather than new common stock the firmās WACC will get decreased. The different sources of raising the capital and cost of each of the source affect the WACC.
• WACC is influenced by the dividend policy of the firm. Higher the dividend payout higher the WACC and minimum dividend payout ratio the lower will be WACC.
• The retained earnings cost is lower than the new equity cost...

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