Why Debt Is Cheaper Than Equity

Photo by Avery Evans on Unsplash

Debt is often considered cheaper than equity when it comes to financing a company’s operations and growth. This is because debt financing typically carries a lower cost of capital than equity financing, making it a more attractive option for companies looking to raise funds.

There are several reasons why debt is cheaper than equity:

1. Interest tax deductibility: The interest payments made on debt are tax-deductible, which reduces the overall cost of borrowing. This tax benefit makes debt financing a more attractive option for companies compared to equity financing, as it reduces their tax bill and increases their net income.
2. Fixed interest payments: Debt financing typically involves fixed interest payments, which provide stability and predictability for the company’s cash flows. This is in contrast to equity financing, where the return is uncertain and dependent on the performance of the company.
3. Seniority in case of bankruptcy: In the event of a bankruptcy, debt holders have priority over equity holders in terms of receiving their investments back. This priority makes debt a more secure investment compared to equity, and thus lenders are willing to offer lower interest rates.

An example of how debt can be cheaper than equity can be seen in the case of a company that needs to raise funds to…