>Assuming the investment works out, it will pay for the cost of borrowing over time.
In other words, because the company is deciding to take on more risk, hoping for better rewards.
I'm recently debt free (I don't own a house), with car, credit cards, loans, everything paid off. It's how I could afford to quit my job and bootstrap my own company last month. Not just financially, but mentally, with buy in from my wife even though we have a four month old baby. Companies don't have four month old babies, and CEOs usually get rewarded nicely when the risks they take with other people's money work out, so the calculations are different for companies than for individuals.
Awesome, congrats on the bootstrapping! Yeah, I agree, many investors have a higher tolerance for risk than someone who's putting the livelihood of their family at stake.
I agree that it's not the same for people as it is for companies. And it's ironic that the rash decisions (read high risk) taken by companies often affects individuals.
Being debt-free is a good financially and mentally, as you say. It's interesting that I am also in a similar situation as you -- I paid off all loans and then could afford to quit my job to bootstrap my company. We're in the same boat, and I'm enjoying every bit of it.
A good example of opportunity cost borrowing is Microsoft. They have borrowed money by issuing bonds, even though they have plenty of cash. In the recession they didn't have to offer high yields on the bonds in order to find people begging to buy them, and they can invest the money they raised at higher rates than they are paying. It's basically free money for them.
Of course, it does open them up to FUD. The Boycott Novell folks were all over it, proclaiming that Microsoft is in debt, and that SEC filings showing Microsoft doing well were the result of cooking the books to hide the truth, and the press is not reporting it because Microsoft bought them all off.
The most important reason is left off the list - Cash Flow.
$10,000 in hand and $10,000 in debt with monthly service of $500 is infinitely better than zero debt and zero cash when a customer delays payment by 30 days because of their cash flow issues and your employees walk because their checks bounce.
Run out of cash and your business can and usually will die if it really is a business.
There are good debts and bad debts. If you use loans to pay a property which earns you $10,000/month whereas your monthly payment to the bank is only $8,000/month, why bother using cash to pay for the property?
You can leverage your cash well and scale the business to many properties and the total down payments you pay might be even less than the price of ONE property.
Good debts are those debts with higher returns elsewhere than the interest of the debts themselves. Using credit instead of cash here is simply free cash-flow.
"Even if the property market crashes, you can always choose to default." There is always someone who loses here (investors who have put money in mortgage backed securities?). Intentionally defaulting is not the most ethical thing one could do, and this kind of thinking has partly helped bring the recession upon us, which no-one could escape. No?
As an individual (not a company), I see my credit card as an interest-free loan until the end of the month. I pay my CC bill in full every month but were something to come up in an emergency I could allocate money as needed and pay the minimum whereas if I had already paid for everything in cash I might be out of luck.
If you feel comfortable and are fairly sure you know what you're spending is going to be like in the next year, it's also possible to take advantage of those "No interest for a full year!!" deals but carrying a high balance (a high percentage of your available credit) can negatively effect your credit score.
Maybe the number one reason is that debt forms a tax shield: Interest payments are an expense which reduces your tax base while dividend payments don't. (see the trade-off theory)
Asymmetric information is another possible reason to prefer debt: If somebody wants to sell something, it often means that he's not happy with it. So what does it tell a potential investor if management wants to sell equity? Thus, management will often prefer to issue debt as to not send a negative signal to the market. (see the pecking order theory)
It's interesting to note that Modigliani & Miller have proven that the financial structure (ratio of equity to debt) wouldn't matter in a frictionless market. There are many theories concerning many different market frictions, e.g. bankruptcy cost, agency problems, etc.
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[ 3.0 ms ] story [ 37.1 ms ] threadIn other words, because the company is deciding to take on more risk, hoping for better rewards.
I'm recently debt free (I don't own a house), with car, credit cards, loans, everything paid off. It's how I could afford to quit my job and bootstrap my own company last month. Not just financially, but mentally, with buy in from my wife even though we have a four month old baby. Companies don't have four month old babies, and CEOs usually get rewarded nicely when the risks they take with other people's money work out, so the calculations are different for companies than for individuals.
Being debt-free is a good financially and mentally, as you say. It's interesting that I am also in a similar situation as you -- I paid off all loans and then could afford to quit my job to bootstrap my company. We're in the same boat, and I'm enjoying every bit of it.
Of course, it does open them up to FUD. The Boycott Novell folks were all over it, proclaiming that Microsoft is in debt, and that SEC filings showing Microsoft doing well were the result of cooking the books to hide the truth, and the press is not reporting it because Microsoft bought them all off.
$10,000 in hand and $10,000 in debt with monthly service of $500 is infinitely better than zero debt and zero cash when a customer delays payment by 30 days because of their cash flow issues and your employees walk because their checks bounce.
Run out of cash and your business can and usually will die if it really is a business.
You can leverage your cash well and scale the business to many properties and the total down payments you pay might be even less than the price of ONE property.
Good debts are those debts with higher returns elsewhere than the interest of the debts themselves. Using credit instead of cash here is simply free cash-flow.
Even if the property market crashes, you can always choose to default. - Nothing lose, this is not your own house.
If you feel comfortable and are fairly sure you know what you're spending is going to be like in the next year, it's also possible to take advantage of those "No interest for a full year!!" deals but carrying a high balance (a high percentage of your available credit) can negatively effect your credit score.
Be careful out there :)
Asymmetric information is another possible reason to prefer debt: If somebody wants to sell something, it often means that he's not happy with it. So what does it tell a potential investor if management wants to sell equity? Thus, management will often prefer to issue debt as to not send a negative signal to the market. (see the pecking order theory)
It's interesting to note that Modigliani & Miller have proven that the financial structure (ratio of equity to debt) wouldn't matter in a frictionless market. There are many theories concerning many different market frictions, e.g. bankruptcy cost, agency problems, etc.