Can lower debt rating increase equity financing cost as well as debt cost? I don’t understand how it affect equity financing cost…
Don’t recall the precise explanation, but a lower debt rating signals a greater default risk. If a default occurs debt would have first claim to assets. i.e. more risky for debt implies more risky for equity. Right?
debt is repaid before equity if the company goes bust, so if the company is perceived as a default risk, piling in equity to fund them is quite a risky move, because if they go bust you may not get anything back
Lower Debt Rating means High Default Risk Hence, Higher return will be required by investors to compensate for taking the risk, therefore a higher cost of debt. While at the same time equity investors to keep holding equity of the company will also require higher return as the company has become riskier and the claim on its assets is on a second priority to creditors.