Give the Advantages and disadvantages of Using Debt Finance.

Answers

ADVANTAGES.
• Interest on debt is a tax allowable expense and as such it is reduced by the tax allowance.
• The cost of debt is fixed regardless of profits made and as such under conditions of high profits the cost of debt will be lower.
• It does not call for a lot of formalities to raise and as such its ideal for urgent ventures
• It is usually self-sustaining in that the asset acquired is used to pay for its cost i.e. leaving the company with the value of the asset.
• In case of long-term debt, amount of loan declines with time and repayments reduce its burden to the borrower.
• Debt finance does not influence the company’s decision since lenders don’t participate at the AGM.

DISADVANTAGES
? It is a conditional finance i.e. it is not invested without the approval of lender.
? Debt finance, if used in excess may interrupt the companies decision making process when gearing level is high, creditors will demand a say in the company i.e. and demand representation in the BOD.
? It is dangerous to use in a recession as such a condition may force the company into receivership through lack of funds to service the loan.
? It calls for securities which are highly negotiable or marketable thus limiting its availability.
? It is only available for specific ventures and for a short term, which reduces its investment in strategic ventures.
? The use of debt finance may lower the value of a share if used excessively. It increases financial risk and required rate of return by shareholders thus reduce the value of shares.

Kavungya answered the question on March 11, 2019 at 13:29

Next: State the Reasons Why Commercial Banks Prefer To Lend Short Term Loans
Previous: Give the Similarities between Preference and Equity Finance

View More Business Finance Questions and Answers | Return to Questions Index

Give the Advantages and disadvantages of Using Debt Finance.

Answers

Exams With Marking Schemes

Related Questions