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Author: cdk4 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 3899  
Subject: Re: The Cost of Financing Date: 8/31/1999 10:19 PM
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Re: the second question.

There are certainly times when it is in the best interests of a firm to finance growth with debt as opposed to equity. You need to look at the cost of each type of capital. Equity capital is often times more "expensive" than debt capital.

As you know, debt financing requires the repayment in scheduled installments at a percentage rate of the principal borrowed. For simplicity's sake, let's say they pay 7%.

Equity financing is not repaid in the same way, but certainly has a real "cost." When someone purchases the company's stock, they typically expect a certain rate of return. The greater the risk in a particular stock, in theory, the greater the expectation for appretiation. This expectation can be defined as the "cost" of equity financing. Should the company not live up to its promise, shareholders will sell it, thus depreciating the stock.

Each company has to evaluate which type of financing is preferable. Naturally, with debt it must make annual payments and therefore needs regular cash flow. Equity financing has to be repaid too, but not necessarily on a fixed schedule.

-Chris
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