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Because debt is a fixed amount that can be repaid, with the owners of the business retaining full ownership after repayment. Equity makes one an owner of a (presumably) growing business and therefore of potentially huge value and an indeterminate loss to the original owners.

AnswerI am not sure I would agree with the above and it seems circular at best (although perhaps it's trying to address the dilution of value to existing stock holders when more stock is issued)- but the common answer is because of the tax effect difference between dividends and interest.

Historically, Business Finance considers debt less expensive than equity because the payments on debt - interest - are before earnings and receive a tax deduction as a business expense. Whereas, dividends, which are how you pay equity financing, are not tax deductible and are paid from after tax earnings.

So, in a 35% tax rate (the current federal corp tax rate), paying $100 of interest has the same cost to the company as paying $65 of dividends. Adding the effect of State taxes, etc. even increases the effect.

Paying the same of in dividends, the amount paid gets no tax benefit and has a real cost of the $100. So, you can carry much more debt for the same net cost as using the dividend/equity option.

Finally, debt (credit line or bonds) can be easily replaced and refinanced should interest rates fall, or the company has a credit rating improvement. Equity, once in place, is there to stay.

AnswerIn addition to the above. Debt is cheaper than equity because providers of debt are exposed to less risks than providers of equity (shareholders). This is because (1) interest needs to be paid out regardless of net income, while dividends can only be paid when the firm has been profitable, and, (2) in case of bankrupcy, debt providers have priority over shareholders.
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โˆ™ 2010-09-16 21:19:53
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Q: Why is debt a comparatively cheaper form of finance than equity?
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Related questions

Compare and contrast debt finance and equity finance?

similarities between equity n debt finance

As debt is a cheaper source of finance than equity companies should be highly geared in order to maximise their market value?


What are the types of project finance?

its through debt or equity

What are the different categories of finance?

Catagories of finance are Debt finance, Equity finance, Long Term finance, Short Term finance

What is debit to equity ratio?

Debt to equity ratio is a measurement criteria to measure how much debt is used in business as compare to owner's capital to finance the business.

How can you decrease owners equity?

Owners equity can be decreased by obtaining finance from debt instead of issuing shares. Zeshan Shahzad 03234449714

If the cost of debt is far less than the cost of equity why do firms not finance entire funding requirement by way of debt?

A firm will not finance its entire funding requirement by way of debt because that will cost it its independence.

What us the differences between debt and equity capital?

Equity capital is the form of finance which is provided by owners of the business while debt financing is form of long term loan which requires to pay interest. Debt financing has the benefit that interest paid for that is tax deductable while equity capital don't have to pay any interest and that's why it is not a tax deductable so for this type of benefit of debt finance companies tries to maintain proper mix of debt as well as equity capital in the business.

What is formula of debt equity ratio?

debt-equity ratio=total debt/total equity

What is the total debt of 1233837 and total assets of 2178990 what is the firms debt to equity ratio?

Debt equity ratio = total debt / total equity debt equity ratio = 1233837 / 2178990 * 100 Debt equity ratio = 56.64%

Debt equity ratio tells about what?

debt equity ration

How can you control your debt ratio and debt to equity ratio?

how to control debt equity ratio

Breckenridge Ski Company has total assets of 422235811 and a debt ratio of 29.5 percent Calculate the companys debt-to-equity ratio and the equity multiplier?

What is given is: total assets = $422,235,811 Debt ratio = 29.5% Find: debt-to-equity ratio Equity multiplier Debt-to-equity ratio = total debt / total equity Total debt ratio = total debt / total assets Total debt = total debt ratio x total assets = 0.295 x 422,235,811 = 124,559,564.2 Total assets = total equity + total debt Total equity = total assets - total debt = 422,235,811 - 124,559,564.2 = 297,676,246.8 Debt-to-equity ratio = total debt / total equity = 124,559,564.2 / 297,676,246.8 = 0.4184 Equity multiplier = total assets / total equity = 422,235,811 / 297,676,246.8 = 1.418

What is the ebit-eps indifference point?

The EBIT-EPS indifference point is a calculation used in determining optimal capital structures. What that means is firms typically finance their operations with two primary means, equity and debt. Back to the indifference point, algebraically and graphically when the earnings per share for debt and equity financing alternatives are equal, you have the EBIT-EPS indifference point. Put another way a firm can finance their operations at the same cost, with either debt or equity, at the indifference point. EPS (debt financing) = EPS (equity financing)

What is the role of finance?

Finance is the life blood of any organisation, any organisation cannot run without finance. Mostly Financial Managers look into the followin matters: - How and which type of finance (debt or equity) should we get? - How to manage them? - How to invest them?

What would be the based on your company Finance Manager equity finance and Debt finance give reason?

it cant be said in direct form whether finance or equity without knowing the nature of company's business, mkt risk, past holdings, position of competitors, and so many. but even then we can say dat if a company is with good market share and strong and well managed financial condition the company can go for equity in the first instance but debt wil b more beneficial because of lower cost .

What is the equity multiplier if a company has a debt equity ratio of 1.40 return assets is 8.7 persent and total equty is 520000?

The equity multiplier = debt to equity +1. Therefore, if the debt to equity ratio is 1.40, the equity multiplier is 2.40.

What is the definition of Weighted average cost?

Weighted average cost includes all types of finances company uses to finance it's business like equity finance, debt finance, loan or debenture etc.

Cost and benefits of debt financing and equity financing?

benefit of debt and equity financing

What is debt to equity conversion?

Debt to equity conversion is also known as hybrid transaction or debt-equity swap. In such a swap, the borrower is allowed to convert his debt into equity shares and the lender of the loan, hence, becomes the shareholder in due process.

How do you solve for debt to equity ratio with an equity multiplier of 2.47?

debt ratio+Equity ratio=1 debt ratio=1-1/2.47=0.6=60%

How do you use structured finance in order to finance buyouts?

Structured finance is the use of various layers of debt and equity to attain the number needed to effectuate the buyout. The assets of the target are used to collateralize a prime layer of debt, a layer of equity is required to make the deal and there is often a layer of debentures, sometimes at the level of junk bonds, based on the presumed ability of the cash flow of the target to pay off.

Which financial statement would best indicate whether the company relies on debt or stockholders' equity to finance its assets?

Balance Sheet

Why cost of equity is higher than cost of debt?

Because in the case of bankruptcy, debt holders are repaid before equity holders, therefore decreased risk for debt. Debt is collateralised by the assets of the firm, equity is not.

What is the debt ratio is total assets are 136000 equity is 31000 current liability is 24000 and total liabilities are 105000?

Debt to Equity ratio =Total liabilities / equity Debt to equity ratio = 105000 / 31000 = 3.387