Financing comes from three sources, retained earnings, debt and new equity. Retained earnings have the lowest cost because of:

A. static trade-off between debt and equity
B. agency costs of equity
C. asymmetry information theory

Correct Answer: C

Information asymmetry leads to higher cost of financing from external parties. In essence, due to information asymmetry, external sources of finances demand a higher rate of return to compensate for higher risk.