Page 39 - 5.2 i. Manac Finance ITC Summarised Notes
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COST OF CAPITAL
Financial Gearing
• The level of debt within a company. It is a measure of financial leverage
(showing the degree to which a company’s operations are funded by debt).
A highly geared company = a company with a lot
of debt!!
• Capital structure = The relationship between debt and equity in financing the
assets of the company.
• Refer to analysis of financial information (ratios) for important capital structure
ratios.
Is debt good / bad???
• The cost of debt (Kd) is lower than the cost of equity (Ke) due to lower risk,
lower expected returns and tax advantages.
• However, the debt brings financial risk into the company’s financial structure
which increases the required return of ordinary shareholders (Ke) and debt
providers (Kd).
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