Question

Optimal Capital Structure:

If debt is the cheapest form of capital why not use 100% debt? explain

Answer 1

Debt is cheapest form of capital only when the company has equal or more equity finance in it's disclosure. Not when it has zero equity and nothing to rely on paybacks to the loans they've taken. Also 100% debt is like over optimistic about future results which is highly improbable for a booming business. Equity is double fold with respect to the debt payments made, in a sense it helps to build wealth of both company the investors invested in it. But when it comes to the debt or loan or debentures, this may sound safe and secure but again heavy interest chargers needed to pay back to the suppliers. Debt only helps build the business further for a financial leverage but cannot entirely depend on the sole source of it. Else, there is highest probability to see the company lose the solvency.