Question

1. A firm has a cost of equity of 13 percent, a cost of preferred of 5 percent, an after-tax cost of debt of 3.4 percent and a tax rate of 21%. Given this, which of the following will increase the firm’s weighted average cost of capital?
   1. Increase the firm’s tax rate
   2. Issuing new bonds at par
   3. Increasing the firm’s beta
   4. Increasing the debt/equity ratio

Answer 1

the concept of risk is hard to factor in stock analysis and valuation, one of the most popular indicators is a statistical measure called beta. Analysts use it often when they want to determine a stock's risk profile. However, while beta does say something about price risk, it has its limits for investors looking to determine fundamental risk factors.

stock that swings more than the market over time has a beta above 1.0. If a stock moves less than the market, the stock's beta is less than 1.0. High-beta stocks are supposed to be riskier but provide higher return potential; low-beta stocks pose less risk but also lower returns.

So from above given option if BETA of firm increases that increase the risk,The basic definition of cost of capital is simply the cost, an entity must pay to raise funds. Cost of equity is a return, a firm needs to pay to its equity shareholders to compensate the risk they undertake, by investing the amount in the firm. It is based on the expectation of the investors, hence this is the highest cost of capital.

So based on above details i can say that

INCREASE IN FIRM'S BETA INCREASES THE WEIGHTED AVERAGE COST OF CAPITAL.

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From Mona....