Suppose your firm’s credit rating is B-, and outlook is negative, not easy to raise finance through debt from the capital market. According to the capital structure theories we examined, benefits by having debt since the interest expense is deductible for tax purposes, creating an interest tax shield. The interest tax shield, on the other hand, increases in value the higher the coupon rate on the debt and the higher the tax rate. Shouldn't the firm then choose to raise as much debt as possible or pay as high a coupon rate as possible given the low credit rating? As CFO, what kinds of concerns you have to issue as much debt as possible, and high coupon rate increase the benefits of tax shields? (300 words limit with bulletin points to answer the above questions)
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Suppose your firm’s credit rating is B-, and outlook is negative, not easy to raise finance through debt from the capital market. According to the capital structure theories we examined, benefits by having debt since the interest expense is deductible for tax purposes, creating an interest tax shield. The interest tax shield, on the other hand, increases in value the higher the coupon rate on the debt and the higher the tax rate. Shouldn't the firm then choose to raise as much debt as possible or pay as high a coupon rate as possible given the low credit rating? As CFO, what kinds of concerns you have to issue as much debt as possible, and high coupon rate increase the benefits of tax shields? (300 words limit with bulletin points to answer the above questions)
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