Debt Finance Essay

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What are the advantages and disadvantages of using debt financing? [10] Debt financing is the act of a business raising operating capital or other capital by borrowing. Most often, this refers to the issuance of a bond, debenture, or other debt security. In exchange for lending the money, bond holders and others become creditors of the business and are entitled to the payment of interest and to have their loan redeemed at the end of a given period. Debt financing can be long-term or short-term. Long-term debt financing usually involves a business' need to buy the basic necessities for its business, such as facilities and major assets, while short-term debt financing includes debt securities with shorter redemption periods and is used to provide day-to-day necessities such as inventory and/or payroll. This form of financing has the following advantages and disadvantages: Advantages • Maintain ownership: When you borrow from the bank or another lender, you are obligated to make the agreed-upon payments on time. But that is the end of your obligation to the lender. You can choose to run your business however you choose without outside interference. • Tax deductions: This is a huge attraction for debt financing. In most cases, the principal and interest payments on a business loan are classified as business expenses, and thus can be deducted from your business income taxes. It helps to think of the government as a “partner” in your business, with a 30 percent ownership stake (or whatever your business tax rate is). If you can cut the government out of the equation, then it’s beneficial to your business. • Lower interest rate: Furthermore, you should analyze the impact of tax deductions on the bank interest rate. If the bank is charging you 10 percent for your loan, and the government taxes you at 30 percent, then there is an advantage to taking a loan you can

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