It is based on a theory. Essentially, the WACC (weighted average cost of capital).
The idea is that all “Capital” whether from a stock holder or bond holder demands some rate of return. Bonds interest coupons are explicit, stocks return whatever profits remain.
When you think about it that way, adding debt actually allows for more growth/spending because the overall (weighed) rate of borrowing actually decreased before it increases when interest rates are low (and the tax shield helps since some interest in debt is deductible - usually about a third of it).
It’s leverage. It does increase risk. Just imagine if you used a credit card to buy a tool and used this tool to expand your business. Same concept. You’d better be sure that spending will pay for itself.
jeremevans t1_j9tv5js wrote
Reply to comment by app4that in [OC] Apple’s 2022 Income Statement Visualized with a Sankey Diagram by Square_Tea4916
It is based on a theory. Essentially, the WACC (weighted average cost of capital).
The idea is that all “Capital” whether from a stock holder or bond holder demands some rate of return. Bonds interest coupons are explicit, stocks return whatever profits remain.
When you think about it that way, adding debt actually allows for more growth/spending because the overall (weighed) rate of borrowing actually decreased before it increases when interest rates are low (and the tax shield helps since some interest in debt is deductible - usually about a third of it).
It’s leverage. It does increase risk. Just imagine if you used a credit card to buy a tool and used this tool to expand your business. Same concept. You’d better be sure that spending will pay for itself.