power and mystery of debt..!

This topic may appear counter intuitive as the prevailing mindset is to shun off debt. This viewpoint has passed from one generation to another that any thought of having debt is looked down with disdain. However, we have often failed to analyse the power of debt and the wonders it can do to the financial health of an entity whether it be a firm or an individual. We should be more open to debt and embrace it in our investment decisions on a case to case basis.

First of all, debt is cheaper than equity and the presence of tax shield makes it highly cost effective. Thus we can reduce our cost of capital by having a part of our capital financed by debt. Thus we can generate value even in the financing decision. If there is a worthwhile project, we should always have debt in our overall capital structure.

Secondly, a small amount of debt induces a sense of discipline with regard to cash flow management. People become more responsible and do not engage in value destroying investments. Moreover, it promotes a sense of innovation on the part of management as they start looking for new revenue streams to augment present cash flows. The end result is that the organization is stretched from its comfort zone and it gives rise to new value creating equilibrium.

Its only when the greed takes over our logic that we go for higher leverage (more than 80%) that the system yields and everything comes crashing down.

so enjoy debt within a limit...!!!