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CMA Intermediate · Financial Management and Business Data Analytics · Capital Structure and Capital Stacking

Which statement about moving down the capital stack from senior secured debt to common equity is correct?

Moving from senior debt toward common equity, the priority of claim declines while the required return increases, because the lower layers absorb losses first and rank last in repayment, so investors demand compensation for the extra risk.

  1. APriority of claim falls while required return risesCorrect
  2. BPriority of claim rises while required return rises
  3. CPriority of claim falls while required return falls
  4. DPriority of claim and required return both stay constant

Explanation

Lower layers bear losses first and rank later in repayment, so investors demand higher returns for taking greater risk. Hence priority declines as required return increases.

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