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If dividends paid to common stockholders are not legal obligations of a corporation, is the cost...

Question:

If dividends paid to common stockholders are not legal obligations of a corporation, is the cost of equity zero? Explain your answer.

Cost Of Equity:

The cost of equity is the financing cost that the firm will need to meet the required return from the shareholders' perspective. The cost of equity has an impact on the average cost of capital to the entire firm.

Answer and Explanation:

The cost of equity can be drawn from the expected dividends. However, if the dividends are not paid out, it does not mean that the cost of equity equal to zero. From the shareholders' perspective, the cost of equity or the required rate of return is the opportunity cost that the shareholders give up other investments for the equity investment in the firm. For instance, instead of placing the money in a savings account with an interest rate of 10% annually, the investor would expect to earn more than 10% when investing in a firm.


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Cost of Capital: Flotation Cost, NPV & Internal Equity

from Corporate Finance: Help & Review

Chapter 3 / Lesson 18
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