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CS Executive · Corporate Accounting and Financial Management · Cost of Capital

A firm's marginal cost of capital schedule rises at certain levels of total financing. Which is the usual reason for this rise, as taught in cost of capital?

The marginal cost of capital rises because cheaper sources, such as retained earnings or lower-interest debt, run out at certain amounts of financing. The firm must then raise costlier new equity or higher-rate debt, which pushes the weighted cost of each additional rupee upward.

  1. ARetained earnings are exhausted and costlier new equity or higher-cost debt must be usedCorrect
  2. BTax rates on corporate income are reduced automatically
  3. CPreference dividends become tax deductible
  4. DThe book value of existing equity increases

Explanation

The MCC schedule steps up at break points where a cheaper source, such as retained earnings or low-cost debt, is exhausted and a more expensive source must be tapped. The other options do not cause the schedule to rise.

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