Question
Which of the following statements is incorrect about the sources of finance used by companies: Long-term internal sources of finance come from the company's own reserves, like retained earnings. The company's choice between different external sources of finance could impact its overall cost of capital. Debt and equity are a source of internal finance available for the firm. The higher the risk associated with a source of finance, the higher the expected return from investors.
Answer
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Bruce
Master · Tutor for 5 years
Answer
Debt and equity are a source of internal finance available for the firm.
Explanation
## Step 1: Understand the source of finance categories for companiesCompany financing can be categorised into two primary types, namely, internal and external. Internal sources of finance are generated within the organization and include revenue from operations, retained earnings, and sale of assets. On the contrary, external financial sources include share capital, issued bonds, financial institutions loans, venture capitalists, and so forth. ## Step 2: Evaluate each statement based on the category and conceptsIn light of this understanding of finance sources, let’s now analyze each statement:a) Long-term internal sources of finance come from the company's own reserves, like retained earnings - This statement is correct. As internal finance is sourced through the company's own fund concentrations and operations, long-term sources indeed can come from reserves such as retained earnings.b) The company's choice between different external sources of finance could impact its overall cost of capital - This is accurate. The weighted average cost of capital, or WACC, of any business depends on how it charts its financial course with respect to both debt and equity. So, any variation in the debt-equity ratio due to choices of external finance will indirectly affect WACC.c) Debt and equity are sources of internal finance available for the firm - This statement is incorrect, as it categorically embeds entities as internal resources, however, both these financial variables are essentially linked with external finance.d) The higher the risk associated with a source of finance, the higher the expected return from investors - This holds truth in financing because, according to the risk-reward concept of finance. Investors generally look for higher returns to compensate for higher risk.