Debt And Equity Essay Samples

When a business needs money to invest on starting up, expansion, and development, they commonly raise money by debt and equity. Financing your business by debt means that you borrow money for the business. Meanwhile, equity financing is investing your own and other stakeholders’ money into the business. Each of these has their corresponding costs: cost of debt is the rate of interest charged on the loan you have made; while cost of equity is the return expected by those who invested money to the business.
On the long-run, the cost of equity can be more expensive than the cost of debt. This is because of the very high risk in equity financing. Unlike debts which are secured by assets, equity owners cannot seize anything as the business is not owned by any single person. Debts are secured against securities with less risk of loss, bringing fewer returns and therefore lesser costs. However, the risk of loss for equity shareholders are very high as it is not secured against any security such as assets, thus equity holders expect higher returns. Moreover, in the occasion of a bankruptcy, debt holders are repaid before equity holders, thus there is a decreased risk of debt.
Sometimes, however, this does not hold true. When a company has too much debt, the cost of debt does outweigh the cost of equity, and lenders would hesitate into lending money to the business. That is why usual set-up for most businesses is a mix of both debt and equity financing, as each has its own advantages and disadvantages that complement each other.