Question

Public debt arises as a result of financing successive budget deficits through borrowing. The public debt stock as at March 2020 stood at GHC 236.1 billion according to the Bank of Ghana. There have been arguments for and against borrowing by government and the opposition all these years depending on where they find themselves.
As a student of Public Finance, is borrowing good or bad? Justify your position by coming out with all the relevant arguments for and against your decision

Answer 1

Borrowing is sometimes good and sometimes bad because it is dependent upon the capability of the borrower to repay the amount of the loan and if loans are resulting into a financial solvency risk, then it is not good for company.

when the companies having adequate amount of earnings and it is able to earn high rate of return on its overall capital, then the cost of debt would be lower than the rate of the return and in this case when the cost of the debt is lower than the overall rate of return, it will mean that my company is making a growth out of the borrowing, so it can continue to take more debt and help its expansion and growth.

when the company is not having adequate amount of return on its overall capital and borrowings then the company is not able to beat the cost of debt and it is always facing a solvency risk and the bankruptcy risk, so there would be cost of bankruptcy and financial distress associated with the overall borrowing, hence in these cases,borrowing is not good for the company because it can lead to to dissolution of the company because of its inability to pay the debt because it is not making appropriate amount of Return.

So it can be summarised that when the return of capital is greater than the cost of debt, then a company should be borrowing more, whereas when the cost of debt is higher than the return on the capital then the company should be focusing on equity and other methods of investment rather than going for debt financing.