1. Assignment
F-501: Introduction to Finance
Topic: “Is Debt Financing Always Bad?”
Submitted To:
NAUSHEEN RAHMAN
Professor
Department of Finance
University of Dhaka
Submitted By:
MD. ARMAN HOSSAIN A.B
ID NO: 30006
Department of Finance
Master of Business Administration (Evening)
University of Dhaka
Submission Date:
July 11, 2015

2. Is Debt Financing Always Bad?
Finance may seem like a complex discipline and full of dense concepts but the field
is founded upon and mostly consists of a few simple concepts. One example is that
there are basically two ways to finance a business, assuming the owner doesn’t
have enough money on hand: By selling ownership stakes in the company
(otherwise known as equity), or by taking out debt (borrowing money from an outside
source with the promise of paying back the borrowed amount with the agreed-upon
interest at a later date).
We all know about the crushing effect of debt on our economy. However, many
companies tend to carry more debt than equity because it would not be rational for a
public company to be funded only by equity. It’s too inefficient. Debt is a lower cost
source of funds and allows a higher return to the equity investors by leveraging their
money. So, there are times when debt financing can be a good thing.
There are several clear positive results why a company should use debt to finance a
large portion of its business by borrowing money from a bank or issuing bonds to the
public. These are as follows:
1) Benefits of Tax Deduction: Government encourages businesses to use debt
by allowing them to deduct the interest on the debt from corporate income
taxes. Our interest expenses are tax deductible.
2) Flexible Repayment system: Our only obligation to the lender is to repay the
loan at predetermined dates. Loans from close relatives can have flexible
repayments terms.
3) Control over Actual Management: We’ll give up no control over the actual
management of the firm like the equity financing.
4) Low Risk Provision: Equity is riskier than debt. Because a company typically
has no legal obligation to pay dividends to common shareholders, those
shareholders want a certain rate of return. Debt is much less risky for the
investor because the firm is legally obligated to pay. Much of the return on
equity is tied up in stock appreciation, which requires a company to grow
revenue, profit and cash flow. An investor typically wants at least a 10% return
due to these risks, while debt can usually be found at a lower rate.
5) Better Option for Ongoing Needs: To finance a startup venture, it’s better to
seek equity investments, because it needs only have to repay investors if the
business turns a profit. For ongoing needs, loans are better for businesses
with cash flow that allows for realistic repayment schedules, and for
businesses that can obtain the loan without jeopardizing personal assets.
However, financing a business entirely with debt is bad. The reason behind that is
all debt, or even 90% debt (bankruptcy risk), would be too risky to those providing
the financing. A business needs to balance the use of debt and equity to keep the
average cost of capital at its minimum.
In sum, debt is a tool which can play an important part in creating long-term wealth if
it is used correctly. But used by the financially reckless, debt can be a deadly
weapon.