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Greg --

This is a somewhat simplistic response to your quetion, but it's a little piece I prepared for our weekly syndicated newspaper feature (for info on how to get it into your local paper:

It might offer some insights for you or some others.


The Fool School

Debating Debt

Many investors think that debt on a company's balance sheet is a red flag. In truth, though, debt can be both bad and good.

First, the bad. If a company is saddled with a lot of debt, it's locked into interest payments that it must make. If it doesn't have the cash to cover these at any point, it's in deep doodoo. Many individuals can probably relate to this, having experienced the dark side of debt when racking up charges on credit cards.

Now, the good. Consider that most people would never be able to buy their homes without debt. Without car and school loans, many of us would probably be driving used cars and taking correspondence courses we found on matchbook covers.

Debt can be a boon for businesses, too. Many great companies, such as Federal Express and the Walt Disney Co., came to life because of early loans to their founders. Established companies can make good use of debt, as well, borrowing to expand operations and grow business. Interest payments also decrease a company's taxable income, as they're deductible. Investors willing to consider companies with debt need to evaluate whether the debt taken on is manageable and whether the capital raised and invested is earning more than it costs.

Perhaps you're worried about the debt load of Fingernail-on-Blackboard Car Alarm Co. (ticker: AIEEE). Glance at the notes in the annual report and you may find that the effective interest rate for its debt is just 5 percent. If AIEEE is putting the borrowed funds to work earning say, 8 percent, then things aren't so bad.

When companies need money, they typically have two main choices: They can issue more stock or debt. Issuing stock can dilute the value of existing shares. Issuing debt can sometimes be more efficient, as its after-tax cost can be much cheaper than equity. All things being equal, though, we prefer to see little debt on a balance sheet.

Companies that can grow without using debt or issuing extra stock are in a more powerful position than other firms. Still, you needn't balk at the first sight of debt. Just evaluate it carefully.
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