The cost of debt is lower than the cost of other

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Unformatted text preview: t any earnings or assets available for payment. (2) They can exert far greater legal pressure against the company to make payment than can holders of preferred or common stock. (3) The tax deductibility of interest payments lowers the debt cost to the firm substantially. Unlike debt capital, which must be repaid at some future date, 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 Struc...
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