DEBT FINANCING

Debt Financing

Debt Financing

Debt financing associated with the provision of legal persons of a loan - loans (loans). Features of debt financing are that it is allocated for specific interests, and received at its facilities, together with interest must be repaid within a specified period.

It is the purpose of the company - to fill the lack of funds for business, the purpose of the lender - makes the money work and be profitable. That is why the loan or loans are made after studying the company's business plan and assess all the financial risks of this move.

In traditional macroeconomic analysis of investment financing is often treated implicitly, very schematically. Everything happens as if there was only one type of financial instrument, interest-bearing securities and as if all the investment was financed through the issuance of such securities. The reality of modern business seems very different directions since we can see financial plans of complex financing for their investments playing on self-financing, the issuance of bonds, capital increases, bank credit.

The leverage effect plays an important role in the decision to finance the investment. We assume that a firm issues debt and equity capital to acquire productive of value to the firm a random rate of return. The yield for each shareholder is the random yield of net capital of the interest payment to creditors and divided by the number of shares issued. This shows that the debt is to leverage their firms to increase above the average rate of return of capital rate of return to shareholders they serve.

Indeed the rate of return on capital is generally higher interest rate and thus the average rate used to shareholders is even higher than the 'lever' (debt / share) is high. Firms thus have an interest in debt and leverage that has been invoked to explain especially during the 70s trend of French companies in a growing indebtedness. It is clear that the debt has not only advantages. If it increases the average return for shareholders, it also increases the risk they face since all risk is borne by a smaller amount of actions. So the risk when the 'lever' increases.

One is then tempted to consider that there is an optimal leverage resulting in a tradeoff between risk and return. In fact, this is not so sure when we take into account the complete balancing of the financial sphere, where the framework is that of the Modigliani-Miller theorem. According to them, financial structures adopted by firms are unimportant. But in reality, the existence of taxes and market imperfection makes it unrealistic. I.e. too much debt a company is more likely bankruptcy. The existence of capital while helping to make companies less vulnerable.

One must also question the transparency of companies. There are problems of asymmetric information between managers, shareholders and creditors. In practice, entrepreneurs are better informed about their investment projects that potential outside investors. However, the external financing of a business depends on ...