Question
13.1 Critique this statement: The use of debt financing lowers the net income of the firm and
hence debt financing should be used only as a last resort
."
Debt financing occurs when a firm raises money for working capital or capital expenditures by
selling debt instruments to individuals and/or institutional investors. In return for lending the
money, the individuals or institutions become creditors and receive a promise that the principal
and interest on the debt will be repaid
. The debt financing is a term used to represent the
borrowed money received from outside with the agreement to pay back the principal with
interest. When the debt financing increases, the net income of the borrower decreases but it will
also give tax benefit. Debt financing should be used only as a last resort because debt financing
can damage the financial stability of the company. In debt financing, the company needs to pay
back the borrowed money including interest, and sometimes they will suffer due to limited cash
flow and difficulty in pay back the money.
13.2 What is meant by a firm's debt capital.
Debt capital is the capital that a business raises by taking out a loan. It is a loan made to a
company, typically as growth capital, and is normally repaid at some future date.
capital that a
company acquires by incurring debt. This type of business capital holds tremendous value as a
source of finance. It enables a company to leverage fortunate financial circumstances into
obtaining capital without selling portions of its equity or ownership. Debt capital is acquired by
using a security of the company as collateral to receive a
loan
from an investor. This investor is
issued a
debenture
in exchange for the loan. Debt capital exchanges normally involve the
investor receiving a fee or interest payment for their investment. Investors who are issued
debentures hold a security, are creditors of the company, and are entitled to interest payments.
One of the main characteristics of debt capital that sets it apart from equity capital is the fact that
the company goes into debt to acquire capital
