When it comes to choose between (portions) of debt and equity to be issued by a company, we should evaluate more than just their costs.
Let’s find out the economic and non-economic implications of debt and equity.
Debt has interests to be paid, which constitutes the cost of debt, while equity does not.
That means debt has a fixed repayment schedule, while equity does not.
But debt has a lower cost than equity, since equity is riskier and expected to be repaid in dividends and capital appreciation.
Issuing debt, on the other side, prevents the dilution of equity, so shareholders can keep the same percentage of ownership equity, in fact, guarantees the right to vote on company decisions.
Last but not least, in case of liquidation of the company, lenders have the first claim on the net assets, while shareholders have the last claim on them
Anyway, a tradeoff between the two types of financing should also consider how much operational flexibility equity can give compared to the rigidity of debt.
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