Question

There are several factors to consider before a company uses debt financing. Discuss 3 main determinants of borrowing, other than tax shield（500 word)

Answer 1

Determinants of Debt Financing

A company may consider several factors before taking decision on Debt financing. One of the main reason for which a company go for debt financing is the Tax Shield. Only debt capital brings tax shield benefits. Thus the cost of debt becomes cheap.

Other main Three Determinants are discussed below:

1. Size of the Company / Tangibility : Big firs tend to have high liquidity position. So the company can pay off its debt easily. It will not reach in the situation of bankruptcy. Larger firms may opt debt financing than smaller ones. Another reason is Tangibility. Companies with sufficient collateral will get loans easily than other companies

2. Stability of earnings / Profitability: Before taking loans, companies should analyse the stability of earnings or Profitability. If a company is not making profits, it is better to avoid debt financing. When the company go for debt financing, it should ensure its repayment capacity.

3. Managerial ownership: The type of ownership of the copany is athe another factor which affect the debt financing decisions of the company. Preference for debt financing for partnership firms, private company and public company will be different.

The above discussed are the determinats of debt financing other than tax shield.