Which type of equity is generally considered more expensive?

Common equity is generally considered more expensive than other types of financing due to several key factors. Firstly, common equity represents ownership in a company and comes with the highest level of risk for investors. Shareholders require a higher return on their investment to compensate for this risk, as they are last in line to be paid in the event of liquidation after creditors and preferred shareholders.

Moreover, the cost of common equity is influenced by market conditions, the company’s performance, and the expected future growth rates. Investors anticipate high returns to justify their investment, which leads to a higher expected cost of equity compared to debt or preferred equity. The required return on common equity often reflects the potential for capital gains and dividends that investors expect, which further drives up its cost.

In contrast, debt is usually cheaper because it provides fixed interest payments and has the priority claim over equity in the capital structure in case of liquidations. Preferred equity may also have a lower cost than common equity due to its fixed dividend payments and use of a priority claim for dividends. Retained earnings, being internally generated funds, do not incur new costs, but are often viewed as a cheaper source of equity than issuing new common stock.