The calculation of after-tax cost of debt versus the cost of equity plays a major role in managing capital costs for a company. Knowing the difference between cost of debt and cost of equity would determine how you would manage the cost of capital within a company.

You are the CFO of a company that is considering issuing its first bond issue to the public.

You have been asked to present a few matters related to debt (bond) financing to the board of directors.

Please briefly explain to the board: 1) the usual collateral position of bondholders (lenders) versus equity investors, 2) why common stockholders can demand a higher rate of return than lenders, and 3) why you would suggest debt (or equity) financing.