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Principles of finance - Essay Example

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“In a world with corporate taxes, Modigliani and Miller’s view is that a company should issue as much debt as possible. Why is this advice not followed by companies?”A debt is often an obligation owed by a debtor to a creditor, who is usually the second party…
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Download file to see previous pages In this case, the debtor is the companies in question. In most cases, this is termed as assets granted, particularly by the creditor to the debtor. The debtor agrees to repay the debt with an interest. Some companies use debt as part of their strategy in corporate finance. Before the debt is issued, both parties have to agree on the standard of deferred payment. In most cases, this repayment is in the mode of currency (Blum 2006). However, this repayment can be in the form of goods and services. Payment can be paid in installments or in the whole amount at the end of a loan agreement. A company offers different kinds of debts to customers to finance its operations. There are secured and unsecured debts, depending on whether the creditors have recourse to the assets of the borrower or not. In addition, there are private or public loans depending on the parties involved. One of the main reason why companies tend not to issue as much debt as possible is the fear of becoming bankrupt. If a company issues more debt than its stipulated capital, then the possibility of bankruptcy is usually high. This is especially in unsecured debts, and the borrower happens to forfeit payment. If this happens with a considerable number of borrowers, then the company can be at an extreme risk (DePamphilis 2011). Therefore, these companies offer debts amounting to the given budget. The financial advisors of the company advise the top managers on the considerable amount of debts to issue that would not alter the normal functioning of the company in any way. Secondly, a company may not be in a position to offer as much debt as possible. This is because the company may be undergoing some harsh economic times. Therefore, the company’s initial capital might be limited to offering a given amount of debt. During this period, some companies may not offer any debt at all. Therefore, the amount of debts a company offers is often guided by the economic situations of the company particularly the capital in place (Forsythyl 2009). In addition, most of the risks involved may deter a company from issuing as many debts as possible. The companies, with the help of their financial advisers, look into all the risks in all the risks involved before issuing the debts. These risks may be as a result of economic downtowns, variability in the interest rates experienced and changes in the conditions of the market. Some companies tend to take the risks but obviously at a minimum (Prattie 2011). Fewer companies are willing to take many risks, therefore, tending to issue a limited amount of debts as possible. Moreover, some of these companies tend to put in place a lot of terms and conditions required before one gains access to these loans. Therefore, some debtors tend to bark out of the lending process due to all these requirements. Some of the requirement of a company before issuance of debts is collateral mostly in the form of assets. The debtor may not possess the required collateral and, therefore, may not be legible to qualify for a debt from a certain company in question. In addition, the interest rates required by the company may be too high for the debtor not forgetting the question of having to follow the covenant made in the process. More to this is that this debt has to be repaid. Therefore, the investor or debtor in question has to have a stable cash flow to be in a position to repay in the stipulated time (Black 2010). Therefore, the appetite in making investment decisions is reduced. As a result, fewer debtors would be in a position to take the risk because a few of them have a stable cash flow. They may, therefore, fear the consequences that follow a forfeited debt payment therefore reducing the amount ...Download file to see next pagesRead More
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