Candidates were asked here to discuss why the cost of equity is greater than the cost of debt. Most well-prepared candidates should have done well with this question.

As with question 2(b), the key to answering this question was risk. As a source of finance, equity is riskier to the investor than debt, for several reasons, and so the cost of equity is higher than the cost of debt. Better answers discussed the creditor hierarchy on liquidation, the legal requirement to pay interest on debt, and the tax efficiency of debt. Some weaker answers discussed pecking order theory, occasionally at length, but this was of no relevance to the question asked. Other weaker answers discussed capital structure theory, again occasionally at length, but this was also of no relevance to the question asked.