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Hi Greg,

The question of how much debt is too much is a tough one. I would refer you to Graham & Dodds book Security Analysis, chapter 40 on Capitalization Structure.

The gist is;

"...frequently the stockholders will be better off if the company has a moderate amount of debt than if it has none."

"However, one of the effects of a highly leveraged capital structure is to make the market value of the enterprise highly unpredictable."

"That damage done by excessive debt needs no argument, and the history of our railroads points up that moral only too well. But it would be naive to assume from such examples, that all corporate debt is bad and to be avoided. If that were so, the only companies that would deserve good credit would be those that never borrowed."

"In our view the question whether corporate borrowing is desirable or undesirable is to be decided not as a matter of general principle but by reference to the circumstances of the case. For some companies it is dangerous to owe more than a nominal amount ; hence not enough money could be soundly borrowed to make the transaction worthwhile."

"In the case of nonutility enterprises the soundness of the debt structure cannot be judged by reference to the book value of the stock equity, since there is no assurance that earnings will be commensurate with the book investment.Thus the primary criterion of sound borrowing is not the balance sheet but the income account over a number of years past and a businesslike appraisal of the hazards of the future."

It seems like Graham & Dodd view debt as a factor that if things go well and debt is moderate can add value to a company but if debt is too high and/or things go poorly can greatly reduce or eliminate the value for stockholders. The key variables would seem to be making sure that the income stream can support the payment of interest & principle over time even in mediocre or poor business environments.

ZB
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