Hello! This is a good question!
To begin with, when companies refer to debt versus equity;
they are usually comparing the cost methods of obtaining financing.
During the comparison of the cost of debt and equity, we will need to consider the interest that a company would pay over the lifetime of the loan and the portion of profits that the owner would sacrifice over the lifetime of the company. If the interest paid on the loan is less than an outside investor’s cut of the company’s profits, then debt would be less expensive, and vice versa.
Debts are usually finite since the company would not have any more obligations to the lender once their loan is fully repaid. This would mean that the more profitable a company is, the more costly it will be to sacrifice equity.
Equity holders are likely to have a higher risk as there is a chance of them losing everything should the company fail, thus they would demand a greater return to compensate them for taking on this additional risks. While for debts, the risks is not as high since there is a fixed amount.
In conculsion, debts are usually cheaper since the amount of money that they risk losing is likely to be lower than that of equity.
Hello! This is a good question!
To begin with, when companies refer to debt versus equity;
they are usually comparing the cost methods of obtaining financing.
During the comparison of the cost of debt and equity, we will need to consider the interest that a company would pay over the lifetime of the loan and the portion of profits that the owner would sacrifice over the lifetime of the company. If the interest paid on the loan is less than an outside investor’s cut of the company’s profits, then debt would be less expensive, and vice versa.
Debts are usually finite since the company would not have any more obligations to the lender once their loan is fully repaid. This would mean that the more profitable a company is, the more costly it will be to sacrifice equity.
Equity holders are likely to have a higher risk as there is a chance of them losing everything should the company fail, thus they would demand a greater return to compensate them for taking on this additional risks. While for debts, the risks is not as high since there is a fixed amount.
In conculsion, debts are usually cheaper since the amount of money that they risk losing is likely to be lower than that of equity.