If dividends paid to common stockholders are not legal obligations of a corporation, is the cost of equity zero? Explain your answer.
Even though common stockholders don't have a contractual claim on dividends the funds supplied by stockholders definitely have a cost. Equity investors are paid last and thus they are taking the greatest risk among all the suppliers of capital. If the company doesn't earn a enhance rate of return on equity funds to compensate for the higher risk taken by equity investors, the price of the stock will drop and so the value of the firm.