Analyzing Assertion (A): New Capital Issue Cost

Assertion (A) states that issuing New Capital is more expensive than utilizing Retained Earnings.

• Issuing new capital, especially equity, involves significant flotation costs. These include fees paid to investment bankers, legal fees, and registration costs. These direct costs increase the effective cost of raising capital through new issues.
• Retained Earnings represent profits the company decides to reinvest rather than distribute as dividends. Using retained earnings avoids the direct flotation costs associated with new security issuance.

Therefore, Assertion (A) is correct because the additional costs of issuing new securities make them costlier compared to using internal funds like retained earnings.

Analyzing Reason (R): Cost of Retained Earnings

Reason (R) defines the cost of Retained Earnings as the return shareholders forgo on their potential dividend income.

• This cost is essentially the opportunity cost for shareholders. When earnings are retained, shareholders give up the immediate benefit of dividends, which they could have otherwise invested to earn a return.
• This opportunity cost is typically approximated by the required rate of return on the company's equity.

Reason (R) correctly describes the nature of the cost associated with retained earnings.

Evaluating Assertion-Reason Relationship

Both Assertion (A) and Reason (R) are factually correct statements within corporate finance.

• Assertion (A) is true because flotation costs make new capital issues more expensive.
• Reason (R) is true because it accurately defines the opportunity cost of retained earnings for shareholders.

However, Reason (R) does not provide the reason *why* new issues are costlier than retained earnings. The explanation for (A) lies primarily in the flotation costs incurred during new capital issuance, not in the definition of retained earnings cost. While retained earnings are cheaper partly due to the absence of these costs, Reason (R) only defines the cost of retained earnings itself, not the comparative cost advantage.

Consequently, while both are correct, (R) is not the correct explanation for (A).