Question

Which one of the following is not the internal factor affecting the weighted average cost of capital of a firm?

• A. Investment policy of the firm
• B. Capital structure of the firm
• C. Dividend policy followed
• D. Market risk premium for the firm

Answer 1

Answer: (D)

Market risk premium for the firm

Internal factors that affect the Weighted Average Cost of Capital (WACC) of a firm includes the following:

• Capital structure of the firm: A business entity has a control over its capital structure. The more the debt, higher will be the cost of such debts; higher the equity, higher will the cost of equity.
• Dividend Policy of the firm: It relates to studying the Price-Earning ratio. If this ratio increases, cost of retained earnings decrease which is the result of reduced earnings that are retained to be used as a source of fund.
• Investment policy of the firm: Company makes investments with lesser risks. As the policy changes, so does the impact on cost of debt and cost of equity.

The market risk premium is the difference between the expected return on a market portfolio and the risk-free rate. It does not form a part of internal factors affecting the WACC of a firm.