Cost of capital: All debt or all equity financing

The issue of capital structure is important because it impacts the cost of a company's capital. Cost of capital is the cost of obtaining external financing, which is a combination of the cost of borrowing and the cost of equity investment. The cost of borrowing is just the interest rate on the loans. The cost of equity investment is the return that investors need to expect to encourage them to invest in a project. The cost of equity investment is what we compute using the capital asset pricing model. Well, who cares about the cost of capital? Well, the cost of capital is critical because it determines which projects are going to be profitable and which projects are not. For example, let's say my cost of capital is 11 percent, and I'm looking at a project that will generate returns of 15 percent. How beautiful! I get my external financing at a cost of just 11 percent. I use that to launch a project that is going to generate returns of 15 percent. I've generated a surplus of four…