Problem
Corporate Finance (U.8)
Topic: Presentation to the Board of Directors, the Pros and Cons of Debt Financing
The calculation of the after-tax cost of debt versus the cost of equity plays a major role in managing capital costs for a company. Knowing the difference between the cost of debt and the cost of equity would determine how you would manage the cost of capital within a company.
You are the CFO of a company that is considering issuing its first bond issue to the public.
You have been asked to present a few matters related to debt (bond) financing to the board of directors.
Briefly explain to the board: (i) the usual collateral position of bondholders (lenders) versus equity investors, (ii) why common stockholders can demand a higher rate of return than lenders, and (iii) why you would suggest debt (or equity) financing.