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CMA Intermediate · Financial Management and Business Data Analytics · Cost of Capital

A data analyst at a Mumbai firm reviews the firm's marginal cost of capital schedule. Which statement about the concept is correct?

Marginal cost of capital is the weighted cost of the next rupee of new capital raised. It normally rises as more is raised because cheaper sources like retained earnings run out and costlier external funds are needed.

  1. AMarginal cost of capital is the historical average of past financing costs weighted by book values
  2. BMarginal cost of capital is the weighted cost of the next rupee of new capital raised, and it normally rises as larger amounts are raisedCorrect
  3. CMarginal cost of capital is always equal to the cost of retained earnings
  4. DMarginal cost of capital falls continuously as more capital is raised because of tax shield on equity

Explanation

Marginal cost of capital is the weighted average cost of raising an additional rupee of new funds, using target or market weights. It typically rises beyond certain amounts as cheaper sources such as retained earnings are exhausted and costlier new equity or debt is needed. Historical book-value averages describe the existing cost, not the marginal one.

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