Based on his own analysis, Tom is recommending that the company increase its use of equity financing because, “debt costs 12.5 percent, but equity only costs 10 percent; thus equity is cheaper.” Ignoring all the other issues, what do you think about the conclusion that the cost of equity is less than the cost of debt?
Cost of equity has a tax component and cost of debt has protection from tax component ac tax shield. So cost of equity and cost of debt can only be compared in absolute terms after readjusted for income tax rates. So Tom statement is not right. Equity is not cheaper
The stament made by Tom is Incorrect.