This week’s question, is easy to answer but could open us up
to a range of complex topics that I don’t think I could cover in just one post.
Thus think I might just stick to the basics and dive deeper into the topic at a
later date (Feel free to email me and request this post sooner if you are
interested at illuminatingfinance@gmail.com.
I try to answer questions that will help the most people, so I won’t even try
and pretend it isn’t a popularity contest in my inbox!)
“Could you please explain what is meant by debt and equity capital?”
A very over simplified explanation would be that debt
equity leaves the firm with an obligation to repay negative cash flows to the
lender (often through loans). Whereas equity capital dilutes the existing value
of the equity of the firm but does not require repayment (often through issuing
shares). Both options have their advantages and disadvantages but we will explore this in more depth in another post. At its basic level this question revolves around the
capital structures of firms. Firms can choose to finance their projects using a
combination of debt capital and equity capital resulting in different capital structures. The different capital structures have different positive and negative
qualities in terms of future cash flows, tax consequences and future
investment opportunities.
I realise this is a very basic explanation of this topic and
as I said above, I will write another more extensive blog post if you are
interested. It would explain the different options firms having for capital
structures and how managers weigh the costs and benefits when deciding how to
finance the firm’s investments.
