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Cost of equity > Cost of debt Reason: When u issue debt, for example in the form of bonds, u have to pay bondholders interest. This interest is tax deductible. On the other hand, when u issue equity, i.e. stocks, u pay dividends. This dividend is taxed as corporate income. Because of the ability of debt to escape taxation vis-a-vis equity, cost of debt is lower than cost of equity. In fact, this is called a debt tax shield.
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Why don't financial managers use as little debt as possible to keep the cost of equity down?
The answer to the question depends on the motivations of management. Increasing debt increases risk should the economy weaken and repayment becomes a problem. Managers who are owners often prefer to minimize debt regardless of its cost so as to preserve a margin of safety in case hard times comes. If the manager is not an owner, debt is attractive because it provides leverage. Suppose a company without debt earns $100,000 on equity of $1 million. Its return on equity is 10%. Now suppose the manager could borrow another $1 million. If he paid 5% interest, he would net $50,000 additional earnings. Note that the resulting $150,000 of earnings would be a 15% return on the $1 million of equity. Investors would bid up the price of the stock based on the higher return on equity. The Cost of Debt: when a company borrows funds from a financial institution, the interest amount paid on that debt is called cost of debt. Cost of Equity: When a company raises money from shareholders by issuing more shares to them or shares to new shareholders, then the dividend (interest) paid to them is called cost of equity. The use of debt lowers the cost of capital not the cost of equity. Debt holders are paid back before equity holders, therefore there is a decreased risk for debt. Because of the ability of debt to escape taxation vs equity, cost of debt is lower than cost of equity. With all that said; Debt costs less than equity financing, because it is tax deductable vs dividends, that are not tax deductable. Debt to a bank though is more risky from a company's perspective because of liquidation risk vs stock value risk. Maximizing shareholder value is the goal of a company, but risking losing the company and one's job, to the bank and liquidation vs a decrease in stock value, is usually preferable. But, one of the main reasons that financial managers don't use as little debt as possible is because using it allows companies to do projects that they otherwise might be able to afford.
Is underwriting spread for debt is generally less than that for equity?
yes
What is ideal debt to equity ratio?
Debt-to-Equity ratio compares the Total Liabilities to the Total Equity of the company. It paints a useful picture of the company's liability position and is frequently used. Debt-to-Equity Ratio = Total Liabilities / Shareholder's EquityBoth the Total Liabilities and Shareholder's Equity are found on the Balance Sheet.When this number is less than 1, it indicates that the company's creditors have less money in the company than its equity holders. That, typically, would be an ideal threshold to be below.It's common for large, well-established companies to have Debt-to-Equity ratios exceeding 1. For instance, GE carries a Debt-to-Equity ratio of around 4.4 (440%), and IBM around (1.3)130%.
Is capital structure relevant to the value of the firm?
It should be in regards to the forecasts regarding debt and equity markets. A firm more heavily exposed to debt will be exposed to the constant variable nature of that debt and other relevant debt covenants - eg over the last 5 years firms have favored debt due to cheap debt markets but are now suffering from high debt claiming high interest repayments etc. Equity is less of a drag on cash flow but can limit organizational effectiveness in regards to the greater power of shareholders.
How does one obtain a debt consolidation loan using the equity in your home?
Debt considation - equity in homeYou may restructure your debt using your equity in your home 2 ways. 1. you may obtain a home equity line of credit - less fees usually a adjustable rate 2. refinance your 1st mortgage and cash out to pay off debt - fixed rate, higher fees. You need a mortgage consultation to determine which option is better for you.
Why does the weighted average cost of capital of firms that uses more debt capital lower that that of a firm that uses less debt capital?
Because the cost of debt is generally lower than the cost of equity. This is because in case of financial distress, debt-holders are repaid before the equity holders are, as well as because debt has the assets of the firm as collateral and equity does not.
How does a firm's tax rate affect its cost of capital?
Tax rates, which are influenced by the president and set by congress, have an important impact effect on the cost of capital. Tax rates are used when we calculate the after-tax cost debt for use in the WACC. In addition, the lower tax rate on dividends and capital gains than on interest income favors financing with stock rather than bonds. Lowering the capital gains tax rate relative to the ordinary income would make stocks more attractive, which would reduce the cost of equity relative to that of debt. This would lead to a change in a firms optimal capital structure toward less debt and more equity.
Is debt to equity ration generally equal or less than the debt to asset ratio?
less
Why don't financial managers use as little debt as possible to keep the cost of equity down?
The answer to the question depends on the motivations of management. Increasing debt increases risk should the economy weaken and repayment becomes a problem. Managers who are owners often prefer to minimize debt regardless of its cost so as to preserve a margin of safety in case hard times comes. If the manager is not an owner, debt is attractive because it provides leverage. Suppose a company without debt earns $100,000 on equity of $1 million. Its return on equity is 10%. Now suppose the manager could borrow another $1 million. If he paid 5% interest, he would net $50,000 additional earnings. Note that the resulting $150,000 of earnings would be a 15% return on the $1 million of equity. Investors would bid up the price of the stock based on the higher return on equity. The Cost of Debt: when a company borrows funds from a financial institution, the interest amount paid on that debt is called cost of debt. Cost of Equity: When a company raises money from shareholders by issuing more shares to them or shares to new shareholders, then the dividend (interest) paid to them is called cost of equity. The use of debt lowers the cost of capital not the cost of equity. Debt holders are paid back before equity holders, therefore there is a decreased risk for debt. Because of the ability of debt to escape taxation vs equity, cost of debt is lower than cost of equity. With all that said; Debt costs less than equity financing, because it is tax deductable vs dividends, that are not tax deductable. Debt to a bank though is more risky from a company's perspective because of liquidation risk vs stock value risk. Maximizing shareholder value is the goal of a company, but risking losing the company and one's job, to the bank and liquidation vs a decrease in stock value, is usually preferable. But, one of the main reasons that financial managers don't use as little debt as possible is because using it allows companies to do projects that they otherwise might be able to afford.
Explain Net Operating Income approach to capital structure?
The Net Operating Income approach is the opposite of the Net Income approach to capital structure. With this approach, any change in leverage will not necessarily affect the market value of shares.
Is underwriting spread for debt is generally less than that for equity?
yes
What is ideal debt to equity ratio?
Debt-to-Equity ratio compares the Total Liabilities to the Total Equity of the company. It paints a useful picture of the company's liability position and is frequently used. Debt-to-Equity Ratio = Total Liabilities / Shareholder's EquityBoth the Total Liabilities and Shareholder's Equity are found on the Balance Sheet.When this number is less than 1, it indicates that the company's creditors have less money in the company than its equity holders. That, typically, would be an ideal threshold to be below.It's common for large, well-established companies to have Debt-to-Equity ratios exceeding 1. For instance, GE carries a Debt-to-Equity ratio of around 4.4 (440%), and IBM around (1.3)130%.
Is capital structure relevant to the value of the firm?
It should be in regards to the forecasts regarding debt and equity markets. A firm more heavily exposed to debt will be exposed to the constant variable nature of that debt and other relevant debt covenants - eg over the last 5 years firms have favored debt due to cheap debt markets but are now suffering from high debt claiming high interest repayments etc. Equity is less of a drag on cash flow but can limit organizational effectiveness in regards to the greater power of shareholders.
Do banks take less money on home equity loans to clear the debt faster?
Hello
Can we do a private placement memorandum combining equity and bonds?
Companies that are seeking to raise capital without going through the publicly traded exchanges can offer equity or debt to accredited private investors through a private placement memorandum (PPM).A PPM does not have to be registered with the Securities and Exchange Commission, is a less costly method of raising capital than going public, and allows a company to have more control over who has the right of disclosure to its financial information.A private placement memorandum can be for debt, equity, or a combination of both types of securities.
How does one obtain a debt consolidation loan using the equity in your home?
Debt considation - equity in homeYou may restructure your debt using your equity in your home 2 ways. 1. you may obtain a home equity line of credit - less fees usually a adjustable rate 2. refinance your 1st mortgage and cash out to pay off debt - fixed rate, higher fees. You need a mortgage consultation to determine which option is better for you.
Is a money market fund risky?
No, the money market funds are not risky as compared to the equity funds. They are just debt funds. In the money market the volatility is much less than in the equity market, that is why it is not risky.
