Question

Arrange the cost of capital of unlevered ownership, loan ownership and levered equity ownership from the highest to the lowest.

Group of answer choices

a) loan, unlevered and levered equity

b) unlevered, loan and levered equity

c) levered equity, unlevered and loan

d) levered equity, loan and unlevered

Answer 1

Correct option : Option (b) : Unlevered, loan, and levered equity

The reason is that the unlevered equity has the highes borrowing cost since the equity holders bears the maximum risk with no fixed return. They are the ones that bear all the shortfall of funds at the time of liquidation. On the other hand, loan has a lower borrowing cost as in contrast to equity as the repayment schedule is fixed with fixed interest. The lowest of them all is the levered equity which is basiclly a mix of debt and equity. Debt is a much cheaper source of fianance as in comparison to equity. The interest is a tax deductible expense for the company which reduces the overall cost of borrowing for the company.