Question

Please no handwritten or copied answers

How can leveraging debt or a fixed-cost asset affect the capital structure of a business?

Answer 1

Leveraging Debt and its effects on capital structure

Debt does not dilute the shareholding of the investors of the business. However, the principal amount and the interest amount accused has to be paid back.

• Though initially it is taken as a positive cash flow, debt comes as a liability on the balance sheets
• Interest payable is a new liability on the balance sheets (accounts payable head)
  • This reduces the cash flow and the net income
• Reduction in net income, reduces the tax liability and thus brings in a tax relief

Fixed-cost assets and its effects on capital structure

The fixed cost asset always remain in the asset books of the capital structure. However, this asset value gets depreciated over time.

Thus the fixed cost asset value declines with every passing year, affecting the total assets on the balance sheet. This can be reversed, in case the assets are re-furnished or improved upon by adding more money to it.

The fixed cost assets remain a next-to-liquid asset for the company.