How do debt and equity differ in the costs and risks involved? Explain.
How do debt and equity differ in the costs and risks involved? Explain.
Debt and equity are the two major sources of capital for the business. But, these two are different from each other. Both have their set of benefits and limitations.
Debt capital is that kind of capital that needs to be borrowed to be repaid at a later date, the borrower needs to pay a certain amount of interest to the lender. Debt is generally obtained for long term investment purposes.
Companies need to pay off the interest on capital to lenders before announcing any dividends. Therefore, it is quite a secure form of investment.
On the other hand, equity capital is obtained from the funds contributed by the owners, therefore it does not have an obligation to be repaid. Equity, in general, provides a lesser return on investment than debt.
The cost of equity is more than the cost of debt and it is a risky form of investment as the shareholders will only get returns if the company makes a profit, but in the case of debt, the lenders need to be paid a fixed rate of interest for loans.
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Debt and equity are the two major sources of capital for the business. But, these two are different from each other. Both have their set of benefits and limitations.
Debt capital is that kind of capital that needs to be borrowed to be repaid at a later date, the borrower needs to pay a certain amount of interest to the lender. Debt is generally obtained for long term investment purposes.
Companies need to pay off the interest on capital to lenders before announcing any dividends. Therefore, it is quite a secure form of investment.
On the other hand, equity capital is obtained from the funds contributed by the owners, therefore it does not have an obligation to be repaid. Equity, in general, provides a lesser return on investment than debt.
The cost of equity is more than the cost of debt and it is a risky form of investment as the shareholders will only get returns if the company makes a profit, but in the case of debt, the lenders need to be paid a fixed rate of interest for loans.
Also read:
Learn about more questions and answers on business studies and various other commerce topics from our website.
