Final answer:
The cost-effectiveness of financing with debt versus equity varies. Debt financing involves regular interest payments but gives the firm control, while equity financing dilutes ownership but doesn't require interest payments. The decision depends on factors such as interest rates and a firm's preference for control.
Step-by-step explanation:
When a firm needs financial capital, it has to decide between financing with debt or financing with equity. The main answer to which is cheaper can vary based on the circumstances of the business and market conditions. Debt financing, like loans or bonds, involves the commitment to pay scheduled interest payments regardless of the company's income, and allows the company to maintain operational control without shareholder intervention. Equity financing, on the other hand, entails selling ownership through stock which means the company comes under the purview of a board of directors and its shareholders.Additionally, during early-stage financing, companies often rely on personal savings, credit, or external private investors such as venture capitalists or angel investors, due to the impracticality of an IPO or other traditional forms of borrowing that require a financial track record.In conclusion, whether debt or equity financing is cheaper depends on factors like current interest rates, the potential for growth, and the willingness to share control of the business. Firms typically weigh the cost of interest payments against the cost of diluting ownership when making a decision.