Review question 71 lg2 lg3 what are the key

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Unformatted text preview: be lower than the cost of equity financing. Review Question 7–1 LG2 LG3 What are the key differences between debt capital and equity capital? 7.2 Common and Preferred Stock A firm can obtain equity, or ownership, capital by selling either common or preferred stock. All corporations initially issue common stock to raise equity capital. Some of these firms later issue either additional common stock or preferred stock to raise more equity capital. Although both common and preferred stock are forms of equity capital, preferred stock has some similarities to debt capital that significantly differentiate it from common stock. Here we first consider the key features and behaviors of both common and preferred stock and then describe the process of issuing common stock, including the use of venture capital. Common Stock The true owners of business firms are the common stockholders. Common stockholders are sometimes referred to as residual owners because they receive what is left—the residual—after all other claims on the firm’s income and assets have been satisfied. They are assured of only one thing: that they cannot lose any more than they have invested in the firm. As a result of this generally uncertain position, common stockholders expect to be compensated with adequate dividends and, ultimately, capital gains. 310 PART 2 Important Financial Concepts Ownership privately owned (stock) All common stock of a firm owned by a single individual. closely owned (stock) All common stock of a firm owned by a small group of investors (such as a family). publicly owned (stock) Common stock of a firm owned by a broad group of unrelated individual or institutional investors. par value (stock) A relatively useless value for a stock established for legal purposes in the firm’s corporate charter. preemptive right Allows common stockholders to maintain their proportionate ownership in the corporation when new shares are issued. dilution of ownership Occurs when a new stock issue results in each present shareholder having a claim on a smaller part of the firm’s earnings than previously. rights Financial instruments that permit stockholders to purchase additional shares at a price below the market price, in direct proportion to their number of owned shares. authorized shares The number of shares of common stock that a firm’s corporate charter allows it to issue. outstanding shares The number of shares of common stock held by the public. treasury stock The number of shares of outstanding stock that have been repurchased by the firm. issued shares The number of shares of common stock that have been put into circulation; the sum of outstanding shares and treasury stock. The common stock of a firm can be privately owned by a single individual, closely owned by a small group of investors (such as a family), or publicly owned by a broad group of unrelated individual or institutional investors. Typically, small corporations are privately or closely owned; if their shares are t...
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This document was uploaded on 01/19/2014.

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