All else being equal, which method would a company prefer to use when acquiring another company – cash, stock, or debt?

How to answer

Assuming the buyer had unlimited resources, it would always prefer to use cash when buying another company. Why? • Cash is “cheaper” than debt because interest rates on cash are usually under 5% whereas debt interest rates are almost always higher than that. Thus, foregone interest on cash is almost always less than additional interest paid on debt for the same amount of cash/debt. • Cash is also less “risky” than debt because there’s no chance the buyer might fail to raise sufficient funds from investors. • It’s hard to compare the “cost” directly to stock, but in general stock is the most “expensive” way to finance a transaction – remember how the Cost of Equity is almost always higher than the Cost of Debt? That same principle applies here. • Cash is also less risky than stock because the buyer’s share price could change dramatically once the acquisition is announced.