Companies need to remain within their cost of capital range. By deviating they risk getting out of this range and end up paying too much to raise money. By paying too much to raise money the company would be better of borrowing money.
This is because by borrowing they would be getting money at a relatively low after-tax interest rate. They then can buy back some of the more expensive equity Ludwig, (2000). This then implies that the cost of financing with debt is always considerably lower than financing with equity. The other risk is that by moving too far away from the range the company will end up paying too much to raise money. This will cause lenders and stockholders view the company as being too risky. The company should either pay down the debt or issue new equity. This should be done in the next round of financing to reduce the risk and to move back into the range Michael, (2003).
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