Goldberg Corp is a Jenkintown, PA based company founded in the 1980s. Their CFO

Question

Goldberg Corp is a Jenkintown, PA based company founded in the 1980s. Their CFO is forecasting the anticipated costs of capital on their sources of investment financing for a potential investment into a rap music video. Goldberg Corp uses debt and common stock (no preferred stock) to finance its investments. Thinking carefully about the risk characteristics of each form of finance and any transaction costs they might have, the forecast relationships among the component costs of capital: the after-tax cost of debt, rdT, the cost of retained earnings (i.e., internal equity), rRE, and the cost of new, or external, equity, rE. Which of the following relationships should be correct for Goldberg Corp?

rdT < rRE < rE

rRE < rdT < rE

rE < rdT < rRE

rE < rRE < rdT

None of the above is a correct relationship.

rdT < rRE < rE

rRE < rdT < rE

rE < rdT < rRE

rE < rRE < rdT

None of the above is a correct relationship.

Explanation / Answer

Always after tax cost of Debt is lower than the Equity costs

In equity Retained earnings will have lower cost because it is avalable internally

hence rdT < rRE < rE is correct (Option 1)

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