Businesses often need external money to maintain their operations and invest in future growth. There are two types of capital that can be raised: debt and equity.

Debt Capital

澳洲幸运5官方开奖结果体彩网:Debt financing is capital acquired through the borrowing of funds to be repaid at a later date. Common types of debt are loans and credit. The benefit of debt financing is that it allows a business to leverage a smal﷽l a๊mount of money into a much larger sum, enabling more rapid growth than might otherwise be possible.

In addition, payments on debt are generally tax-deductible. The downside of debt financing is that lenders require the payment of interest, meaning the total amount repaid exceeds the initial sum. Also, payments on debt must be made regardless of business revenue. For small✨er or newer businesses, this can be especially ꦕdangerous.

Equity Capital

澳洲幸运5官方开奖结果体彩网:Equity financing refers to funds generated by the sale of stock. The main benefit of equity financing is that funds need not be ꦉrepaid. However, equity financing is not the "no-strings-attached" soluti🔴on it may seem.

Shareholders purchase stock with the understanding that they then own a small stake in the business. The business is then beholden to shareholders and must generate consistent profits in order to maintain a healthy stock 澳洲幸运5官方开奖结果体彩网:valuation and pay dividends. Since equity financing is a 𓂃greater risk to the investor than debt financing is to the lender, the cost of equity is often higher than the 澳洲幸运5官方开奖结果体彩网:cost of debt.

How to Choose Between Debt and Equity

The amount of money that is required to obtain capital from different sources, called 澳洲幸运5官方开奖结果体彩网:cost of capital, is crucial in determining a company's optimal 澳洲幸运5官方开奖结果体彩网:capital structure. Cost of capital is expressed either꧅ as a percentage o🌳r as a dollar amount, depending on the context.

The cost of debt capital is represented by the interest rate required by the lender. A $100,000 loan with an interest rate of 6% has a cost of capital of 6%, and a total cost of capital of $6,000. However, because payments on debt are tax-deductible, many cost of debt calculations take into account the 澳洲幸运5官方开奖结果体彩网:corporate tax rate.

Assuming the tax rate is 30%, the above loan would have an after-tax cost of capital ꧙of 4.2%.

Cost of Equity Calculations

The cost of equity financing can be calculated using the the capital asset pricing model or CAPM:

$\text{CAPM}=\frac{\text{Risk Free Rate}}{(\text{Company's Beta}\ \times\ \text{Risk Premium)}}$CAPM=(Company’s Beta × Risk Premium)Risk Free Rate​

By taking into account the returns generated by the larger market, as well as t🔯he individual stock's relative performance (representedꦯ by beta), the cost of equity calculation reflects the percentage of each invested dollar that shareholders expect in returns.

Finding the mix of debt and equity financing that yields the best funding at the lowest cost is a basic tenet of any prudent business strategy. To compare different 澳洲幸运5官方开奖结果体彩网:capital structures, corporate accountants use a formula called the 澳洲幸运5官方开奖结果体彩网:weighted average cost of capital, or WACC.

The WACC multiplies th𝔉e 🔜percentage costs of debt—after accounting for the corporate tax rate—and equity under each proposed financing plan by a weight equal to the proportion of total capital represented by each capital type.

This allows businesses to determine which levels of debt and equity financing are mos꧟t cost-effective.