Question

Explain how the debt mechanism can be a leverage in the company?

Answer 1

Leverage is a corporate term which means company borrowed debt for their expansion or for buying new assets.

Equity is companies own fund and debt is external funds on which companies have to paid interest. Companies having capital structure which includes debt and equity both , called leveraged companies. A substantial amount of debt in capital structure of company gives various tax benefits to the company. Interest on debt is allowed as deduction while computing taxable income. Debt mechanism will help company to grow by providing better tax benefits and easy funds.

Generally companies assets give higher return as compare to interest expenses. which means company is earning more than what he needs to pay for the borrowed funds to finance the capital. A balance amount of debt in capital structure is always good for companies overall growth as higher debt capital carries risk of higher interest expenses.

Hence is can be said that debt mechanism will help company to expand and grow.