Question

what are the different sources of capital available for a company to get funds ? what is the cost associated with them ?

Answer 1

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There are three main sources of capital available to raise funds. They are:

• Retained Earnings: The company usually invest their retained profits by not paying dividends and ploughing back the profits into reinvestment. By this the company do not have to depend on external financing and invest their funds generated internally. The costs associated with raising retained profits is the cost of opportunity costs sacrificed by not investing into other external opportunities and cost of payment of dividend to share holders.
• Equity funds: Due to the disadvantage of payment obligation strings attached with the debt funding, companies prefer to raise equity. They do it by issuing shares to public or institutional/private placement. Equities are also issued to buy assets or acquire other companies too. This is a riskier form of investment as success is not guaranteed. There is no obligation to pay dividend or repay capital back. Thus risk is higher. Hence in order to compensate this, the cost of equity is higher than other forms of capital.
• Debt Funding: Under this form of capital, the company raises debt from public by issuing bonds or borrowing loans from banks and public financial institutions. There is a legal duty of the company to repay the debt and pay the interest. Thus the risk is moderate in this form of capital. Hence the cost of debt is low. Moreover the company enjoys tax shield pertaining to Interest payment.