The Tradeoff in a Balance Sheet Format

Bringing together the benefits and the costs of debt, we can present the trade off in a balance sheet format in table 7.3:

Table 7.3: Trade off on Debt versus Equity

Advantages of Borrowing

Disadvantages of Borrowing

1. Tax Benefit:

Higher tax rates --> Higher tax benefit

1. Bankruptcy Cost:

Higher business risk --> Higher Cost

2. Added Discipline:

Greater the separation between managers and stockholders -- > Greater the benefit

2. Agency Cost:

Greater the separation between stockholders and lenders -- > Higher Cost

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