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A corporation’s cost of debt is typically lower than a corporation’s cost of equity. A reason for this is because corporations get a tax deduction from using debt financing. Thus, assuming a positive tax rate, a firm’s after-tax cost of debt financing is lower than a firm’s before-tax cost of debt financing. The cost of debt financing is equal to the yield to maturity on the company’s bonds. The cost of equity financing can be determined with the Capital Asset Pricing Model or through the dividend yield plus growth rate approach. Beta, a measure of systematic risk, is an input in the CAPM. The beta of the overall stock market is 1. Most betas range from 0.5 to 1.5. The higher the stock’s beta, as is usually the case with technology companies, the higher the cost of equity financing. Even though the cost of debt financing is lower than the cost of equity financing, it doesn’t mean that the company should have an excessive amount of debt in its capital structure, particularly for cyclical companies. The company pays interest to bondholders; during a recession, the company may not generate enough money to pay the bondholders. This may cause the company to eventually file for bankruptcy. On the other hand, there’s no requirement to pay dividends to common stockholders. It’s a positive cash flow signal, though, when a company institutes or increases its dividend. It’s a negative cash flow signal when a company reduces or eliminates its dividend.

References:

DeAngelo, H., DeAngelo, L., & Skinner, D. .J. (1999, December 15). Special dividends and the evolution of dividend signaling. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=198448

Fama, E. F, & French, K .R. (1997, February 1). Taxes, financing decision, and firm value. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1871

Frank, M. Z., & Goyal, V. K. (2007, December 11). Trade-off and pecking order theories of debt. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=670543

Required:

Below are some questions for discussion.

What signals are provided to investors when a company obtains equity financing? What signals are provided to investors when a company obtains debt financing?
Locate a publicly traded company that instituted or increased its common stock cash dividend over the past year. How has the stock been performing? What reason(s) did the company provide for why it instituted or increased the dividend? Next, locate a different publicly traded company that eliminated or decreased its common stock cash dividend over the past. How has the stock been performing? What reason(s) did the company provide for why it eliminated or decreased its dividend?
Preferred stock is another financing option for companies. What is preferred stock? How is the cost of preferred stock financing determined? Name and describe three publicly traded companies that have preferred stock in their capital structure. What is the percentage of preferred stock in each company’s capital structure?

A minimum of three postings are required. You must answer one of the above questions. You do not need to answer all three questions. You must also respond to at least two peers’ posts over two separate days. Please try to add information not previously discussed by others. Please provide factual information (not merely opinions) backed up by details or examples. Your comments should be in your own words and include references in APA format