Financial Modeling Self Study Program

Which is less expensive capital, debt or equity?

Debt is less expensive for two main reasons.  First, interest on debt is tax deductible (i.e. the tax shield).  Second, debt is senior to equity in a firm’s capital structure.  That is, in a liquidation or bankruptcy, the debt holders get paid first before the equity holders receive anything.  Note, debt being less expensive capital is the equivalent to saying the cost of debt is lower than the cost of equity.

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