Question

What are the benefits and risks associated with motorcycle manufacturer, Harley-Davidson, issuing a bond that will increase its debt to assets ratio by 1% to finance an international expansion to Canada?

Answer 1

Harley- davidson long term debt to asset ratio for 2019 is somewhere between 0.4-0.5, somewhere close to that. Most manufcturer when entering a new country to manfacture their products, they do take loan instead of full fledged equity financing by their parent company. When companies enter into contract to borrow money, there is a fixed payment obligation which they have to met. There are benefits as well as risk associated with the raising of bonds.

Benefits

• If the amount is raised in Canadian dollar  through bonds in Canada then the currency exchnage risk for the company will be somewhat mitigated.
• When money is raised through debt, the Interest paid on that amount is tax deductible hence the after tax cost of debt is lower than pre-tax cost of debt.
• Raising money through debt also gives the leverage benefit. Leverage magnifies the return on equity.
• The cost of raising money through debt would be less if the company has a certain market credit standing,which Harley-Davidson surely does have.

Risk :

• The payment obligation has to be met whether the outcome of manufacturing is success or not, otherwise it might create a scenario of bankruptcy.
• Harley-Davidson, debt to asset ratio is around 0.45 but debt to equity ratio is very high, that shows that it is highly leveraged.
• High leverage, in case the unexpected turn of the economic event can be catastrophic for the company.