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and equity).
The cost of debt is readily observable in the market as the yield on debt with
equivalent risk, while the cost of equity is more difficult to estimate.
Cost of equity is typically estimated using the capital asset pricing model
(CAPM), which links the expected return of equity to its sensitivity to the
overall market (see WSPs DCF module for a detailed analysis of calculating
the cost of equity).
8) What is typically higher the cost of debt or the cost of
equity?
The cost of equity is higher than the cost of debt because the cost associated
with borrowing debt (interest expense) is tax deductible, creating a tax
shield. Additionally, the cost of equity is typically higher because unlike
lenders, equity investors are not guaranteed fixed payments, and are last in
line at liquidation.
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