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What are the advantages and disadvantages of long-term debt financing?

Question:

What are the advantages and disadvantages of long-term debt financing?

Long-term debt Financing:

The long term debt financing refers to those loans and the other liabilities which have been taken for more than one year, and they will not become due in the balances sheet of the company within one year.

Answer and Explanation:

Here are some advantages of debt-financing

  • It offers a tax shield. It is a tax-deductible expense, whereas other sources of funds are not tax-deductible. This makes long term debt more affordable than other sources.
  • Here the ownership is not diluted, whereas in equity the business needs to give ownership to the loan provider of the funds.
  • Debt companies do not take part in the company's daily activities.
  • In contrast with equity, it needs less disclosure of internal info to the outsiders. As there is nothing like issuance of a prospectus.
  • It makes the management more major as they need to ensure to pay interest on time and principal repayment at maturity.
  • It limits the money of the business within the business. As in the case of equity, all the remaining profits belong to investor wealth.
  • There is no ballot right provided to debt holders.

Disadvantages of long-term debt financing:

  • Legal obligation to pay regular interest payment and principal at maturity.
  • Heavy fines in case of default.
  • Various long-term debt comes with limiting covenants, which affect the operation and financial choices of the company.
  • It is not good for the company which raises equity also. A boost in the cost of debt causes an increase in the expense of equity also.
  • It can be hazardous to the reputation and goodwill of the business. If a company defaults, its credit reliability is likewise get affected.

Learn more about this topic:

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Sources of Long-Term Financing

from Business 100: Intro to Business

Chapter 23 / Lesson 4
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