Acquiring a Company

In the case of a stock sale the shareholders of the acquired company must agree to sell their stock at the agreed upon price. When it is cash and stock, a certain amount of shares are given up in addition to cash compensation.

Ryansecrest is not asking about the acquired co, he/she is asking about the acquirer.

Correct me if I'm wrong.

the company probably just issues additional shares and dillutes its sharebase

yes, that is what happens most often.

how is debt 'cheaper' than equity? debt needs to be serviced, equity dividends are discretionary.

For business entities, interest payed on debt is a tax deductible expense.

Also the cost of debt is just the interest payments multiplied by the outstanding principal, but the cost of equity is a function of the overall return on equity, or potential capital gains potential, which can be very promising.

Also, when you issue stock, or sell equity you cannot get it back unless the holders agree to sell it back to you (via a buyback), which is very unlikely if it's a growth stock, and even if they decide to sell they'll command a high premium.

But with debt all you owe to the holder of the debt (bond, loan , etc) are interest payments and the final principal at maturity.

With debt you don't give up any voting control and losing capital gains potential is not an issue.

With equity you give up control, capital gains potential, and you may never be able to get it back, so it's more costly and that's what the WACC tries to accomplish.

so is equity more costly because of the required rate of return investors have?

Debt is generally cheaper than equity for the simple reason that it's higher in the capital structure (i.e. there is less risk to creditors in a liquidation than there is to equity holders, who are last in line to get paid), aside from the tax benefits from interest deduction.

Another consideration in doing stock vs. cash is the company's current leverage level. If a company is already highly levered, equity may be the more attractive alternative.

also with debt you don't give up ownership, equity is costly because of the loss of ownership

Not sure I follow the "give up ownership" comment with respect to debt...

Creditors have no ownership claim on a company's assets. They're simply entitled to interest and principal payments insofar as the company's assets can support the payments.

Equity holders are the owners of a company, and hold a claim on a company's assets only after everybody else (including creditors and preferred equity holders) has been paid off.

Higher risk = higher required return on (or "cost of") capital.

It's that simple. Everything else follows from that basic premise.

hence i said you don't give up ownership

Maybe it's the way you're wording it...an equity holder doesn't "give up" ownership until he/she sells shares to someone else. Obviously, the value of that ownership piece can rise or fall (wherein lies the risk), which I suppose is what you meant.

what i think he's trying to say that by issuing more equity, current shareholders "give up" (or rather dilute) their claim on the residual cash flows of the firm, hence the loss of "ownership".

e.g. consider a startup company 100% owned by Mr X. Issuing equity rather than debt to finance his expansion plans will represent a loss of ownership by him due to his diluted shareholding.

thank you