Question

Is it better for a company to finance itself with debt or equity?

Answer 1

It is always prudent to have an optimum capital structure .The optimum capital structure is based upon an adequate proportion of debt and equity to overall capital structure.

There is no specified rule as whether to only use debt & only use equity .It is however dependent upon various factors including need & objective of company.

The equity is better in case where company is looking for diluting it's stake and raise money from money without having any scheduled repayment obligation. It doesn't need any repayment liability.

The debt financing is better in case the company doesn't look for diluting it's stake and it wants to grow with the help of credit and it is okay with periodic repayments liability. The debt financing is better in case where the return on capital invested is Higher than the cost is Debt as it will add to the overall growth of company. Debt always requires payment even the company is in distress so it is only prudent to have debt if you have repayment capability.

One other advantage associated with debt is that it provides with the Tax shielding benefits as interest paid on debt is shielded with tax advantage.

Overall it is always better to have an optimum mix of both debt and equity so that company could maximize it's overall Market value.