| Definition |
The return required by equity investors for investing in a company’s shares. |
The effective interest rate a company pays on its borrowed funds. |
| Source of Capital |
Equity capital from shareholders. |
Debt capital from lenders or bondholders. |
| Risk Level |
Higher risk due to residual claim and variability of dividends. |
Lower risk as debt holders have priority over equity holders in claims. |
| Cost Calculation |
Often estimated using models like CAPM (Capital Asset Pricing Model) or Dividend Discount Model. |
Based on the interest rates on existing debt adjusted for tax benefits. |
| Tax Impact |
No tax shield; dividends are paid from after-tax profits. |
Interest expense is tax-deductible, providing a tax shield. |
| Payment Obligation |
No fixed payment obligation; dividends depend on company profits. |
Mandatory fixed interest payments must be made regardless of profitability. |
| Effect on Financial Risk |
Issuing equity dilutes ownership but does not increase financial risk. |
Increases financial risk due to fixed interest and principal repayment. |
| Impact on Company Control |
Issuing equity can dilute existing shareholders’ control. |
Debt does not dilute ownership or control. |
| Typical Investors |
Shareholders seeking capital gains and dividends. |
Lenders or bondholders seeking fixed interest income. |
| Cost Comparison |
Usually higher than cost of debt due to higher risk. |
Generally lower than cost of equity because of lower risk. |
| Financial Statement Impact |
Dividends are not recorded as expenses, do not reduce net income. |
Interest expense reduces taxable income and net profit. |
| Use in Capital Structure |
Equity forms the permanent capital base. |
Debt is usually used for leverage to optimize capital costs. |
Cost of Equity vs Cost of Debt