When calculating the WACC, why is the cost of equity typically higher than the cost of debt for a company?

Question: When calculating the WACC, why is the cost of equity typically higher than the cost of debt for a company?

Answer options:

• Equity investors have a higher priority claim on assets in liquidation.
• Dividends paid to equity holders are tax-deductible. ✅ Equity entails higher financial risk for investors than debt.
• Equity is easier to obtain than debt financing.

Correct answer: Equity entails higher financial risk for investors than debt.

Explanation: Equity investors bear higher risk than debt holders because they have a residual claim on assets and earnings (common shares). Debt holders have a senior claim and generally less risk, therefore demanding a lower return.