Question

Recommend method(s) to justify additional debt critiquing advantages and disadvantages of debt versus equity with special considerations for various debt instruments and alternative equity financing. Predict new trends in finance as applied to cost of rating drops, refinanced liabilities, restructured long term notes, working capital draws, and other new financing methods becoming more important in today’s economic environment.

Answer 1

Financial leverage measure proportion of debt in capital structure. A firm that employs a relatively large proportion of debt in its capital structure will have a relatively High degree of financial leverage. Interest payment on debt is considered as expense for company. So, company can deduct interest expense from taxable income. So, company need to pay lesser tax because of debt capital. Cost of debt is relatively lower than cost of other type of capital like, cost of equity of cost of preferred stock.

advantage of debt is, An increase in financial leverage will increase the absolute value of EPS, everything else equal. Because, on debt Capital Company is obliged to pay interest only that to interest payment on deductible from the taxable income. If earning power exceeds the interest payment then remaining earning on debt is transferred to equity holder.

Along with higher return risk is also associated with high proportion of use of debt capital. Excess use of debt in capital structure lead to increase the risk of bankruptcy and so financial risk of company increase