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Corporate Debt – Not Always a Bad Thing?

January 22, 2015

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Society trains us to think that debt is a bad thing, but that’s not always the case. For small businesses, the willingness to take on debt may be the key for growth. When facing a growth opportunity, instead of focusing on the interest rate, you should also consider the return on investment.

When debating between borrowing and finding additional equity, debt can have two benefits. First, the cost of debt is cheaper. Second, the interest is tax deductible.

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Let’s use a simple example – A potential investment with cost of $1,000,000; expected pre-tax income of $250,000; business has $600,000 to invest; tax rate of 26%.

  • Scenario 1 – The business is unwilling to borrow the extra $400,000 and therefore the investment does not happen.
  • Scenario 2 –The business brings on an equity investor for the other $400,000. The business’ 60% share of the after-tax income is $111,000 for an 18.5% return on investment.
  • Scenario 3 – The business borrows the remaining $400,000 at 15%. As a result, the business’ income after-tax and interest is $140,600 for a 23.4% return on investment.

Most people would consider a 15% interest rate high, but even under that scenario (Scenario 3), it is still the best option. As your business grows, if you are unwilling to take on debt or are scared off by high interest rates, you may be passing up great opportunities.





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