sources of finance
Anuradha (student) (66 Points)
20 February 2018
Retained earnings or debt fund,which is cheaper source of finance.
2 Replies
Pranjali Sharma
(4 Points)
Replied 26 June 2018
Debt requires you to pay an interest despite of the circumstances, and obviously, the repayment of principal at maturity even if the company isn’t being able to generate sufficient funds to do so. You can reduce the cost of debt by improving your credit-worthiness, and thus a lower coupon rate because of reduced credit risk premium. On the other hand, debt could increase the risk for equity shareholders. Whereas for equity, you just have to pay dividends which isn’t even an obligation and the capital is repaid on the basis of the residual assets only when the company liquidates, and thus, equity has to be a cheaper source of finance because of no such 'primary obligation' as is in the case of debt. Although, the proportion of both the sources contribute to the costs too, since interest on debt is tax-deductible. So, some amount of debt could initially save you from taxes and contribute, rather than harming your capital structure.
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