The H. Houdini Company’s capital structure includes $10,000,000 of long-term debt at an average rate of 12%. The capital structure also includes $3,000,000 of (cumulative) preferred stock, with stated dividends of five percent and

$6,000,000 of common stock. It has no retained earnings.

Required

a. How does the preferred stock affect the risk and potential returns of the long-term debt and the common stock?

b. In what ways might preferred stock be considered debt? How might it be viewed as equity?