Investors crave for companies that are zero debt, believing they are better investments. Ask a CFO or an academic in finance and you would get a different answer. Indeed, debt has a real cost to it, the interest payable. But equity has a hidden cost, the financial return shareholders expect to make. This hidden cost of equity is higher than that of debt since equity is a riskier investment. Interest cost can be deducted from income, lowering its post-tax cost further. Therefore, equity with a slice of debt makes for an optimal capital structure.
Why is debt cheaper than equity? (2024)
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