Cost of Debt Vs. Cost of Equity (Essay Sample)

Cost of Debt Vs. Cost of Equity
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Cost of Debt Vs. Cost of Equity
For long-term projects that are capital intensive, firms usually have two methods of financing; debt financing and equity financing. While Yulianto et al. (2021) describe debt financing as capital acquired through borrowing funds to be paid later with interest, equity financing, on the other hand, refers to capital generated from the sale of equity stock. However, the text identifies two forms of equity financing that firms can use to raise capital for long-term use. These are preferred stock and common stock. While firms that use debt financing are required to pay an interest rate and return the principal amount borrowed, those that use equity financing are, on the other hand, are required to pay the cost of equity to its shareholders without refunding the capital issued from equity (Yulianto et al., 2021). This affirms that the two methods of financing have their cost since firms are required to pay the price for the debt or capital issued.
Between debt and equity financing, equity financing, however, has a higher cost. Therefore, companies using equity financing would be expected to pay a higher cost to acquire the same capital another would get through debt financing ceteris paribus. Generally, obtaining capital through equity normally has a higher cost due to tax benefits that apply when paying interest in debt financing (Petrů & Tomášková, 2020). Basically, in debt financing, tax benefits are applied when paying interest, unlike in equity financing, affirming why obtaining capital through equity is more costly compared to debt. In simple terms, interest on debt is ordinarily tax-deductible, which lowers the overall cost of capital when using debt financing, unlike equity financing (Petrů &