Suppose now that there is not enough internal cash flow and the firm must issue

Question

Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC?

I. rs will decrease and the WACC will increase due to the flotation costs of new equity.
II. rs and the WACC will not be affected by flotation costs of new equity.
III. rs and the WACC will increase due to the flotation costs of new equity.
IV. rs and the WACC will decrease due to the flotation costs of new equity.
V. rs will increase and the WACC will decrease due to the flotation costs of new equity.

Explanation / Answer

when company issue new share of stock then cost of equity will increase because of floatation cost. Since cost of equity will incraese then WACC of the capital will also increase.

hence, Option (III) is correct answer.

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