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Unformatted text preview: , equity capital
is expected to remain in the firm for an indefinite period of time. The two basic
sources of equity capital are (1) preferred stock and (2) common stock equity,
which includes common stock and retained earnings. Common stock is typically
the most expensive form of equity, followed by retained earnings and then preferred stock. Our concern here is the relationship between debt and equity capital.
Key differences between these two types of capital, relative to voice in management, claims on income and assets, maturity, and tax treatment, were summarized
in Chapter 7, Table 7.1. Because of its secondary position relative to debt, suppliers of equity capital take greater risk than suppliers of debt capital and therefore
must be compensated with higher expected returns. External Assessment of Capital Structure
We saw earlier that financial leverage results from the use of fixed-cost financing,
such as debt and preferred stock, to magnify return and risk. The amount of
leverage in the firm’s capital structure can affect its value by affecting return and
risk. Those outside the firm can make a rough assessmen...
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