Explain three forces that can make debt cheaper than equity for corporate financing

Solutions

Expert Solution

The forces that can make debt cheaper than equity for corporate financing are following-

The riskiness: the risk associated with debt is generally lower in comparison of equity and we know that risk and return go hand by hand. Therefore debt financing is usually cheaper than equity financing and interest rates are lower in comparison of dividends as the shareholders need more return to compensate higher risk associated with equity.
Tax benefits: The interest expense on debt of the company is deducted before calculating the taxable profit of the company therefore its reduces the tax liability of the company and make debt financing even more cheaper in comparison of equity financing while dividends paid to equity holders do not have any tax benefit for the company.
Flotation Cost: Flotation cost is the cost of raise the capital. It is generally higher for equity financing and included into cost of capital while for debt financiering; flotation cost is lower which makes it cheaper than equity for corporate financing.

keosha answered 11 months ago

Next > < Previous

Related Solutions

“The cost of equity can never be cheaper than the cost of debt considering an equity...

“The cost of equity can never be cheaper than the cost of debt considering an equity investor is the last taker of funds, should the worse come to worst for the issuer. And he requires compensation for such risk”. Critically evaluate the remark above from the viewpoint of global finance.

Debt is a cheaper source of financing than equity because Group of answer choices equityholders face...

Debt is a cheaper source of financing than equity because Group of answer choices equityholders face greater risk than creditors because of the residual nature of their claim, and they expect a higher return as compensation. interest on debt is tax deductible, but returns to owners are not. All of these are correct. debt is tax deductible, which reduces the effective cost of borrowing. Two of these are correct.

The WACC formula implies that debt is “cheaper” than equity, that a firm with more debt...

The WACC formula implies that debt is “cheaper” than equity, that a firm with more debt could use lower discount rate. Does this make sense? Explain briefly

Generally speaking, the cost of debt is cheaper than the cost of equity. Does it imply...

Generally speaking, the cost of debt is cheaper than the cost of equity. Does it imply that a firm should increase its debt-to-equity ratio to as high as possible such that its corporate cost of capital can be minimized?

discuss at least three differences between debt and equity financing

the cost of common equity financing is more difficult to estimate than the costs of debt...

the cost of common equity financing is more difficult to estimate than the costs of debt anf preferred equity. explain why? Also key issues in calculation of cost of equity and cost of debt.

In a relation to ‘capital structure’ explain the relation between debt financing, equity financing and market...

In a relation to ‘capital structure’ explain the relation between debt financing, equity financing and market value of an organization. Then, provide two different examples of the relation.

Questions: What are the advantages of debt over equity? If debt is cheaper, why would anyone...

Questions: What are the advantages of debt over equity? If debt is cheaper, why would anyone choose equity? How do taxes play a role in this? Assume the following for a standard bond issue within the United States: The face value of the bonds is $95,000. Stated rate on the bond is 8%. Interest is paid every 6 months (8%/2 = 4% every payment). The bonds are due in 10 years. Assume 3 scenarios, the market rate is 8%, 7%,...

Two common forms of financing include debt and equity. Explain these financing options by defining them...

Two common forms of financing include debt and equity. Explain these financing options by defining them in your own words, discussing when each would be most appropriate, and providing an example that illustrates when each method might be preferred over the other. In replies to peers, discuss whether you support the definitions and examples provided using the topic materials

A company needs financing. The CFO is proposing that her company issues debt rather than equity,...

A company needs financing. The CFO is proposing that her company issues debt rather than equity, because interest rates are low and thus debt is clearly cheaper than equity. Do you think the CFO's reasoning is right & Why?

Subjects