7. Factors affecting a firm's weighted cost of capital

The importance of knowing a firms cost of capital

Purple Lemon Fruit Company has two divisions: one is very risky, and the other exhibits significantly less risk. The company uses its investors overall required rate of return to evaluate its investment projects. It is most likely that the firm will become:

Less risky over time, and its value will increase

Riskier over time, and its value will increase

Riskier over time, and its value will decrease

Less risky over time, and its value will decrease

Which of the following statements is correct?

When all other factors are held constant, a higher tax rate will lower a firms weighted cost of capital only if the firm uses debt financing.

The cost of raising funds from retained earnings is usually a lot cheaper than the cost of debt financing, because the firm already possesses the funds in retained earnings.

A firms after-tax cost of retained earnings may be significantly greater than its after-tax cost of debt, because there are so many more of the firms shares of common stock outstanding than there are bonds outstanding.