Debt as Attractive Source of Capital
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Why is debt an attractive source of capital? What risks does a company incur when it uses debt to fund growth? Why will a company that uses 10% debt have less variability in EPS at different levels of income than a company that uses 25% debt? At what cost of debt will there be no difference in EPS at a given level of income?
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This solution of over 500 words is comprised of a detailed explanation to why debt is an attractive source of capital. It also touches on the risks a company endures and how debt affect different levels of income in a company.
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Why is debt an attractive source of capital? What risks does a company incur when it uses debt to fund growth? Why will a company that uses 10% debt have less variability in EPS at different levels of income than a company that uses 25% debt? At what cost of debt will there be no difference in EPS at a given level of income?
Debt finance is more attractive than equity finance because the costs of raising the funds such as the arrangement fees with a bank or issue costs of a bond is lower. The annual return required to attract investors is also less than for equity because investors recognize that investing in a firm via debt finance is less risky than investing via shares. It is less risky because interest is paid out before dividends are paid. Therefore, there is greater certainty of receiving a return ...
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