“Since debt capital is cheaper than equity, companies should resort to one hundred percent use of debt to finance their investments”. Discuss the limitations of the above financing policy.

Limitations of Debt financing
– Restrictive imposed by debt covenants
– It will result in high bankruptcy and agency costs leading to collapse of the firms
– Restrictions imposed by articles of association
– Availability of quality assets to be used as a collateral to secure debt capital
– Availability of cash to repay interest and principal at maturity
– Gradual increase in cost of debt and cost of equity as gearing increases which increases financial risk
– It will lead to poor credit rating hence inability to secure new capital