Retained earnings are another method of internal sources of finance and it is basically an accumulation of profits by a company for its expansion and diversification activities. The advantages of retained earnings are stated below:

• Retained earnings are most useful to expansion and diversification of the business activities.
• Retained earnings are one of the least costly sources of finance since it does not involve any floatation cost as in the case of raising funds by issuing different types of securities.
• If the companies use equity finance they have to pay a dividend. Instead, if the companies use debt finance, they have to pay interest. However, if the company uses retained earnings as sources of finance, they need not pay any fixed obligation regarding the payment of dividend or interest.
• Retained earnings allow the financial structure to remain completely flexible. The company need not raise loans for further requirements if it has retained earnings.
• When the company uses the retained earnings as the sources of finance for their financial requirements, the cost of capital is very cheaper than the other sources of finance. Hence the value of the share will increase.
• Retained earnings provide opportunities for evasion of excessive tax in a company when it has a small number of shareholders.

As can also be understood from the information given the statements in the options I, II, III and V are correct, so the correct answer is D.

The statement “When the company uses the retained earnings as the sources of finance for their financial requirements, the cost of capital is more expensive than the other sources of finance.” is not correct, because “when the company uses the retained earnings as the sources of finance for their financial requirements, the cost of capital is very cheaper than the other sources of finance.” Hence the value of the share will increase.