Question

The firm's overall cost of capital that is a blend of the costs of the different sources of capital. Describe the three possible sources of capital for a firm

Answer 1

The three possible sources of capital are as follows:-

(1)Common stock :- It is an equity instrument which represents proportionate ownership in a firm.Common stock holders are entitled to vote and residual profit after distribution to debt holders or preference share holders

(2)Debt:- It is a fixed income instrument which provides fixed rate of interest to investors.They gets priority over others for repayment at the the time of liquidation or bankruptcy.This source provides tax benefits also as interest is tax deductible.Examples of debt instrument are bonds , debentures etc

(3) Preference shares:-These share are given the priority over common stockholders at the time of payment of dividend or repayment at the time of liquidation .These shares are not entitled to vote unlike common stockholders .Dividend rate is fixed for preference shareholders which is not so in the case of common stock holders