The appropriate ratio of debt to equity is vital in financial structuring of an infrastructure project. Debt financing means borrowing for a particular project with provisions for repayment with interest. In equity financing, the capital is either invested by the stakeholders or by raising money via selling interests in the company (stocks/bonds).
Equity need not be paid back while debt has to be. Additionally equity ownership adds credibility to a venture while high debt projects are considered to be risky. In debt financing, the lender has no claim on the profits generated as opposed to equity owners. And the interest on loans is tax deductible thus providing a tax shield. Furthermore, actions taken by the company need not undergo clearance from the lender as opposed to voting from equity holders for approval (Thomson Reuters, 2013). On the other hand the advantages of equity financing cannot be over emphasized. It adds to the net worth of the venture providing financial strength and preserves the borrowing capacity for future needs ( Ebi Ofrey, 2011).
|Figure 1: Growth: Debt Vs Equity Financing (Sweeney, 2013)|
Both debt and equity have their pros and cons. It is up to the stakeholders in the business venture to analyze and arrive at the option that best suits their needs. Figure 1 (Sweeney, 2013) gives a graphical representation of expected growth via debt and equity financing. Hence, debt financing would be appropriate for business owners who do not want to dilute ownership, have limited ability to raise equity, or share future profits (Sweeney, 2013).