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¶ … Equity and Weighted Average Cost of Capital
The cost of equity is defined by InvestorWords.com as follows.
The rate of return required by a company's common stockholders.
The Weighted Average Cost of Capital, on the other hand, is defined by Ofcom as follows.
The weighted average cost of capital measures the rate of return that a firm needs to earn in order to reward its investors.
From these two elements, the reason why financial managers don't use as little debt as possible to keep the cost of equity down can be derived. Usually, a company makes debts not because of negative causes. It is frequently due to a strategy of a company to use debts as capital on investments where there can be a high rate of ROI. If a company will use as little debt as possible, then the chance of increasing its investments and gaining returns will similarly lessen. Consequently, this can lessen the cost of equity (shareholder's rate of return expectations) because there is lesser investments from which the shareholders can expect earnings. As the cost of equity lessens, the weighted average cost of capital (company's needed rate of return to reward to investors) will similarly lessen. A company will require lesser WACC when the expected rate of return of the shareholders decreases. Despite of this proportional requirements in rate of return, it is however not an advantage for a company to have a decreasing cost of equity and decreasing weighted average cost of capital because it will only mean that the company's earning also decreases. As what accounting principle indicates, as a company earns less, the shareholders also earn less; and, as a company's income increases, the shareholder's income similarly increases. Therefore, using as little debt as possible is not considered by financial managers because it will cause lesser income for both the company and its investors.
References
Office of Communication
http://www.ofcom.org.uk/media/mofaq/telecoms/costcapital2/?a=87101
Cost of Equity
http://www.investorwords.com/1156/cost_of_equity_capital.html
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