Capital structure, debet verus equity
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Should a company have more debt or more equity in its capital structure? Explain your answer. What are some limitations of utilizing debt versus equity in the capital structure?
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Should a company have more debt or more equity in its capital structure? Explain your answer. What are some limitations of utilizing debt versus equity in the capital structure?
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Regarding capital structure, the cost of debt included in the calculation of cost of capital is known as the after-tax cost of debt, which is the interest rate on debt less the the tax savings that result because interest is deductible. In comparison, the cost of equity is raised by retaining earnings (that is, internal equity) or raised by issuing new stock, which is external equity. Because the after-tax cost of debt is lower than the cost of equity, an increase in the target debt ratio will tend to lower the weighted average cost of capital (WACC), and vice versa if the debt ratio is lowered. However, when ...
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