What options are available to organizations for raising capital? How do different capital markets affect the cost of capital to an organization?
Financing Options available
A firm can broadly raise the long-term money that is capital broadly from two types of markets:
1. Debt Market
2. Equity Market
3. Hybrid options such as Preferred stock and Convertible Bonds
Thus firm's capital structure is that mixture of debt and equity. The aim of the optimal capital structure is to minimize its weighted average cost of capital (WACC).
Cost of Capital Markets
1. Debt Market
The after-tax cost of debt is lower than equity for many corporations. This is because it reduces a company's tax liability because interest payments are deductible expenses.
On the other hand increasing amounts of debt raise both the cost of equity capital and the interest rate on debt because of the increasing probability of bankruptcy. In other words, higher amounts of debt raise the financial risk of a company, and this risk is reflected on the cost of all the types of capital the company uses.
As such, the relationship between financial leverage and WACC is not a straight line, but more of a U-shaped curve, with a minimum WACC between the extremes of debt utilization.
Cost of Equity
It is considered to be costly than the debt. It is the required rate of return that a ...
This discusses the Options available to organizations for raising capital