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

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 1 year ago

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