How does a company's capital structure impact its cost of capital?
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2 Answers
A company's capital structure, which is comprised of debt and equity, impacts its cost of capital in two ways. First, the cost of debt is typically lower than the cost of equity, so the more debt a company has, the lower its overall cost of capital. Second, the higher the debt-to-equity ratio, the higher the perceived risk of the company, which can lead to a higher cost of capital.
A company's capital structure represents the mix of debt and equity financing it uses to fund its operations and investments. The cost of capital considers the cost of both debt and equity funding. The more a company relies on debt financing, the higher its cost of capital will be due to the additional risks and obligations associated with debt.