when a company needs money there are three ways to obtain financing sell equity take on debt or use some hybrid of the two equity represents an ownership stake in the company it gives the shareholder a claim on future earnings but it does not need to be paid back if the company goes bankrupt equity holders are the last in line to receive money the other way to raise capital in debt markets is to issue shares of stock in a public offering this is called equity financing 
a company can choose debt financing which entails selling fixed income products such as bonds bills or notes to investors to obtain the capital needed to grow and expand its operations when a company issues a bond the investors that purchase the bond are lenders who are either retail or institutional investors that provide the company with debt financing the amount of the investment loan also known as the principal must be paid back at some agreed date in the future if the company goes bankrupt lenders have a higher claim on any liquidated assets than shareholders special considerationsa firm s capital structure is made up of equity and debt the cost of equity is the dividend payments to shareholders and the cost of debt is the interest payment to bondholders when a company issues debt not only does it promise to repay the principal amount it also promises to compensate its bondholders by making interest payments known as coupon payments to them annually the interest rate paid on these debt instruments represents the cost of borrowing to the issuer the sum of the cost of equity financing and debt financing is a company s cost of capital the cost of capital represents the minimum return that a company must earn on its capital to satisfy its shareholders creditors and other providers of capital a company s investment decisions relating to new projects and operations should always generate returns greater than the cost of capital if a company s returns on its capital expenditures are below its cost of capital the firm is not generating positive earnings for its investors in this case the company may need to re evaluate and re balance its capital structure the formula for the cost of debt financing is kd interest expense x 1 tax rate 