MGM625-0903A-01 Applied Finance for Decision-Making - Phase 3 Essay - 1

MGM625-0903A-01 Applied Finance for Decision-Making - Phase 3 Discussion Board 2 - Essay Example It has been noted that in most cases the debt carries costs which are much lower (Morgan, Redman Smith and Cooper, 2001). The main reasons behind this include, the ownership of the equity holders is not diluted, and higher rates of interest needed due to the higher levels of risk taken, and also the interest paid on the debts do qualify as business expenses. In theory it is good to use debt as a financing source for businesses. This is mainly because of the fact that the interest paid is generally tax deductible and it can be included as business expenses unlike the cost of equity. This ratio reveals the solvency and the capital structure of the company. It is used as an indicator for the leveraging in terms of the debt and also provides for a better understanding of the amount owned and the amount owed. This gives a view of the amount the company can use for borrowing. There are also a few benefits of debt which include the tax benefits, and also inclusion of higher levels of discipline to the management. However, considering the cost of debt, it is seen that it includes, loss of future flexibility cost, agency cost and bankruptcy costs that can be levied on the companies (Samuels, Wilkes and Brayshaw, 2000). The normal reaction would involve an increase in the Long term debts, which would also lead to an increase in the cash on the assets side of the book. This would in turn have a strong affect on the above mentioned ratios. Also the changes might not be appreciated by the creditors. Also the company might also face issues in terms of receiving loans from the banks as well. Use of higher levels of debt financing when compared to the equity financing means the company would have higher financial leverage. It is noted that the interest payments to debtors is normally tax deductible unlike the dividend which is payable to the shareholders. Thus if the company has higher levels of debt