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Difference between debt capital and equity capital on basis of cost and risk ?
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Difference between debt capital and equity capital on basis of cost an...
Debt Equity
Debt capital refers to funds that are borrowed and must be repaid at a later date. While debt allows a company to leverage a small amount of money into a much greater sum, lenders typically require the payment of interest in return for the privilege. This interest rate is the cost of debt capital. If a company takes out a $100,000 loan with a 7% interest rate, the cost of capital for the loan is 7%. However, because payments on debts are often tax-deductible, businesses account for the corporate tax rate when calculating the real cost of debt capital by multiplying the interest rate by the inverse of the corporate tax rate. Assuming the corporate tax rate is 30%, the loan in the above example then has a cost of capital of 0.07 * (1 - 0.3) or 4.9%.
Equity Capital
Because equity capital typically comes from funds invested by shareholders, the cost of equity capital is slightly more complex. While equity funds need not be repaid, there is a level of return on investment that shareholders can reasonably expect based on the performance of the market in general and the volatility of the stock in question. Companies must be able to produce returns – in the form of healthy stock valuations and dividends – that meet or exceed this level to retain shareholder investment. The capital asset pricing model (CAPM) utilizes the risk-free rate, the risk premium of the wider market, and the beta value of the company's stock to determine the expected rate of return or cost of equity.
Typically, the cost of equity exceeds the cost of debt. The risk to shareholders is greater than to lenders since payment on debt is required by law regardless of a company's profit margins.
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Difference between debt capital and equity capital on basis of cost an...
Equity is riskier than debt. Because a company typically has no legal obligation to pay dividends to common shareholders, those shareholders want a certain rate of return. Debt is much less risky for the investor because the firm is legally obligated to pay it...…………………….......……......nd….........................................................................The cost of debt is usually 4% to 8% while the cost of equity is usually 25% or higher. Debt is a lot saferthan equity because there is a lot to fall back on if the company does not do well. Therefore in many ways debt is a lot cheaper than equity
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Difference between debt capital and equity capital on basis of cost and risk ?
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Difference between debt capital and equity capital on basis of cost and risk ? for Commerce 2024 is part of Commerce preparation. The Question and answers have been prepared according to the Commerce exam syllabus. Information about Difference between debt capital and equity capital on basis of cost and risk ? covers all topics & solutions for Commerce 2024 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for Difference between debt capital and equity capital on basis of cost and risk ?.
Difference between debt capital and equity capital on basis of cost and risk ? for Commerce 2024 is part of Commerce preparation. The Question and answers have been prepared according to the Commerce exam syllabus. Information about Difference between debt capital and equity capital on basis of cost and risk ? covers all topics & solutions for Commerce 2024 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for Difference between debt capital and equity capital on basis of cost and risk ?.
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