Which of the following statements is CORRECT? a) The "break point" refers to the point where the...

Question:

Which of the following statements is CORRECT?

a) The "break point" refers to the point where the firm's tax rate increases.

b) The "break point" refers to the point where the firm has raised so much capital that it is simply unable to borrow any more money.

c) The "break point" refers to the point where the firm is taking on investments that are so risky the firm is in serious danger of going bankrupt if things do not go exactly as planned.

d) The "break point" refers to the point where the firm has raised so much capital that it has exhausted its supply of new retained earnings and thus must raise equity by issuing stock.

e) The "break point" refers to the point where the firm has exhausted its supply of new retained earnings and thus must begin to finance with preferred stock.

Retained Earning Breakpoint:

The maximum amount of capital that can be raised by using retained earnings is called the retained earning breakpoint. It assumes a constant capital structure (without increasing the marginal cost of capital) and also a constant dividend payout ratio. Breakpoint for retained earnings = Retained earnings * (1 - Dividend payout ratio ) / Wce , where Wce is the weight of the common equity.

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Answer and Explanation:

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Option D is correct.

The "break point" refers to the point where the firm has raised so much capital that it has exhausted its supply of...

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Capital Structure & the Cost of Capital

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Chapter 15 / Lesson 1
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In this lesson, we'll define capital and a firm's capital structure. We'll also discuss the costs associated with each component in the capital structure and learn about the concept of risk and return.


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