A firm has common and preferred stock outstanding, both of which just paid a dividend of $3 per share. Which do you think will have a higher share price and why? If the firm also has an issue of non-callable debentures outstanding, which do you think investors will require a higher return on, the debentures or the shares of common stock? Explain.

This question sets up some of the material addressed later in the chapter. First, the share of common stock will be worth more since dividends will typically be expected to increase while they will not on the preferred shares. The investor-required return will be higher for the stock since bonds have promised payments and preference over stock in liquidation. The astute student will make the connection that bondholder returns are effectively limited while stockholder returns are effectively not.