Lecture 8 - Long-term Liabilities

Long-term Liabilities

Management Issues
How do you determine whether to borrow money and increase debt or to issue stock to raise stock. Issuing stock dilutes it. It also may decrease shareholder confidence. It also requires more dividends. Debt, on the other hand, increases risk to the company because there is now a liability to repay the debt. Debt has the benefit that the interest on the debt is tax deductible, whereas the increase in dividends to stockholders is not.

Financial Leverage
This is the excess of the Return on Total Investment over the Interest Rate on Debt. It can be either positive or negative.

Positive leverage allows you to increase your return on equity by borrowing at a rate lower than return on investment.

Negative leverage decreases your ROE when you borrow at a high rate than the ROI.

Interest Coverage
Banks make this calculation in determining how much to lend to a firm.

Amount Available to Pay Interest / Interest Expense

Amount available to pay interest = net income + taxes + interest

(Some ppl add back the depreciation, but we don't and the book doesn't.)