Question

the major benefit of debt financing – the tax shield - is easy to calculate, many of the indirect costs of debt financing can be quite subtle and difficult to quantify. They arise, among other reasons, due to the loss of employees, fire sales of assets, and loss of customers in highly levered firms. Explain how these losses arise and which kind of companies are more affected; examples are going to be appreciated.

Answer 1

Many of the indirect cost that are associated with debt financing could be related to the loss of employees, loss of consumers and fire sale of assets. this is because the company has to deal with a lot of non operating expense which are most of interest in nature so to finance the overall debt,the companies cutting onto most of the indirect expense because they do not have adequate liquidity to fulfill their periodic debt repayment schedule.

At the time of adverse economic situations, when the cost of debt, goes higher and the companies facing with the profits going down also and so there is not much of enough liquidity to fulfill the periodic debt repayment schedule, and that lead to cutting down onto indirect expenses of the company which will include firing of employees and sale of assets.

This can be easily visible through at the time of recession in a particular industry, employees are fired out first.