Adantages And Disadvantages Of Long-Term Debt Financing

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Advantages Of Long-Term Debt Financing
From the issuing firm's perspective, the major advantages of long-term debt financing are as follows:

1. Debt is least costly source of long-term financing. It is the least costly because:
* Interest on debt is tax-deductible,
* Bondholders or creditors consider debt as a relatively less risky investment and require lower return.

2. Debt financing provides sufficient flexibility in the financial/capital structure of the company. Flexibility in capital structure of the company can be increased by inserting call provision in the bond indenture. In case of over capitalization, the company can redeem the debt to balance its capitalization.

3. Bondholders are creditors and have no interference in business operations because they are not entitled to vote.

4. The company can enjoy tax saving on interest on debt.

Disadvantages Of Long-Term Debt Financing
Long-term debt financing has some disadvantages from firm's viewpoint as follows:

1. Interest on debt is permanent burden to the company. Company has to pay the interest to bondholders or creditors at fixed rate whether it earns profit or not. It is legally liable to pay interest on debt.

2. Debt usually has a fixed maturity date. Therefore, the financial officer must make provision for repayment of debt.

3. Debt is the most risky source of long-term financing. Company must pay interest and principal at specified time. Non-payment of interest and principal on time take the company into bankruptcy.

4. Debenture indentures may contain restrictive covenants which may limit the company's operating flexibility in future.

5. Only large scale, creditworthy firm, whose assets are good for collateral can raise capital from long-term debt.

From the investor's point of view, in general, debt securities offer stable returns. Further, if the company is liquidated then debenture holders are paid before preferred stockholders and common stockholders. Bondholders are creditors,however, they do not participate in any increased earnings the firm may experience. Similarly, they do not get right to vote.

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2 comments:

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