Question

Which is the lower cost source of finance, equity or debt? And, why would this be?

Thank you

Answer 1

Debt has lower cost of finance because of following reasons:
1. In case of liquidation bond holders or loan givers have first right on the funds. Equity holders are paid after all due are paid to debt holders. Hence risk of equity holders is more than debt holders.
2. Issuance cost of debt is less than equity. In equity shares are issued which have huge costs because of regulatory fees, underwriting fees and issuance costs.
3. Interest on debt is tax deductible whereas dividends on equity are not tax deductible. Hence cost of debt is less than cost o equity.