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In: Accounting

This question focuses on debt, preferred stock, common stock and retained earnings. Make sure that you...

This question focuses on debt, preferred stock, common stock and retained earnings. Make sure that you provide a complete explanation regarding common stock compared to retained earnings. If we construct a graph that has the cost of capital on the vertical axis and the risk of the firm on the horizontal axis, what does the graph look like? Explain.

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Expert Solution

Here we talking about debt , preferred stock , common stock and retained earnings.

1.Debt , it means borrowing capital from the individuals or financial institutions like banks ,t such borrowing amount termed as debt and this borrowing will cost to the borrower in the form of payment of interest for the borrowed capital.

2.Preferred stock , this is also a type share holder here the dividend distribution will be given first to the preferred stock holders and then to the common stock.

3.Common stock, these common share holders are the ultimate owners of the company or an organisation, common stake holders takes the dividend only after payment made to the all financial instruments like debentures, loans, preferred stock, etc.,

4. Retained earnings, these are the Savings made by the promoters before starting the business. Retained earnings will not have any cost of capital, because it's promoters own earings.

> Retained earnings vs Common stock.

Retained earnings are nothing but Savings , where as common stock means capital brought into the company by publishing shares.

Retained earnings will not have any kind of cost of capital, because the capital is not borrowed one. Whereas capital brought by common stock holders expects dividend and ownership.

Contribution made by retained earnings are limited whereas contribution made by common stock holders is unlimited.

Graphical view:

Graphical representation of risk and cost of capital will be like this , please go through the attached file for graph.

The risk and cost of capital view will be upward direction, it means if the cost of capital is more then the risk will be also more and vise versa.

ekkarill92 answered 2 years ago
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