12 Questions
Debt capital only includes short term borrowings incurred by the firm.
False
Equity capital can only be obtained internally by retaining earnings.
False
Preferred stock has no similarities to debt capital.
False
Common stockholders are often referred to as residual owners.
True
All corporations initially issue preferred stock to raise equity capital.
False
Founders' Share is a class of Preferred Stock.
False
Preferred stockholders of par value preferred stock receive fixed dividends stated as a percentage of the face value.
True
Non-cumulative preferred stockholders are guaranteed to receive missed dividends in the future regardless of the company's financial performance.
False
Common stockholders have the right to elect the board of directors and manage the business operations of the corporation.
False
Scrip dividends represent earnings of the business that are distributed to stockholders as cash payments.
False
Participating preferred stockholders have voting rights in the corporation.
True
Pre-emptive rights allow common stockholders to purchase additional shares at a discounted price when new shares are issued.
False
Study Notes
Capital and Its Types
- Capital refers to a firm's long-term funds.
- There are two main types of capital: debt capital and equity capital.
Debt Capital
- Debt capital includes all long-term borrowings incurred by a firm, such as bonds.
Equity Capital
- Equity capital consists of long-term funds provided by a firm's owners or investors, including stockholders or shareholders.
- A firm can obtain equity capital internally by retaining earnings or externally by selling common or preferred stock.
Key Differences between Debt and Equity Capital
- Voice in management: equity capital holders have a say in management, while debt capital holders do not.
- Claims on income and assets: equity capital holders have residual claims, while debt capital holders have fixed claims.
- Maturity: debt capital has a specific maturity date, while equity capital does not.
- Tax treatment: debt capital interest is tax-deductible, while equity capital dividends are not.
Equity Capital: Common Stock
- Common stock represents ownership capital obtained by selling common stock.
- Common stockholders are the true owners of a business firm.
- Classes of common stock include founders' shares and classified stock.
Equity Capital: Preferred Stock
- Preferred stock has some similarities to debt capital.
- Preferred stockholders are promised a fixed periodic dividend, which can be specified as a percentage or a peso value.
- Classes of preferred stock include non-cumulative, cumulative, non-participating, and participating preferred stock, or a combination of these.
Rights of Common Stockholders
Pre-emptive Rights
- Allow common stockholders to maintain their proportionate ownership when new shares are issued.
- Prevent dilution of ownership and earnings.
Control of the Firm
- Common stockholders have the right to elect directors and officers.
- They have voting rights in the corporation.
Right to Receive Dividends
- Dividends represent earnings distributed to stockholders as a return on investment.
- Forms of dividends include cash dividends, stock dividends, property dividends, and scrip dividends.
Test your knowledge on different sources of capital for firms, including debt capital and equity capital. Learn about the key differences between debt and equity financing options.
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