Final answer:
Equity generally costs more than debt financing due to several reasons like legal protection for investors, higher availability of lenders, and risk differences between lenders and investors.
Step-by-step explanation:
Equity generally costs more than debt financing for several reasons:
- Investors have legal protection compared to lenders. This means that if a company fails, equity investors have a higher priority to recover their investment than lenders do. This higher level of risk for investors translates into higher return expectations, making equity financing more expensive.
- More lenders are typically willing to provide debt financing compared to investors providing equity financing. Debt financing is generally considered less risky for lenders because they have legal protection and collateral to secure their loan.
- While lenders have legal protection, investors do not. This means that lenders can take legal action to recover their money in case of default, which reduces the risk associated with lending. The higher level of risk for investors typically leads to higher return expectations.
- More investors are typically willing to provide equity financing compared to lenders providing debt financing. Equity financing allows investors to become partial owners of a company and potentially benefit from its success. This potential for higher returns attracts more investors, making equity financing more easily available but at a higher cost.