[Finterest] How debt can build and crush an empire

Debt can turbocharge a company’s returns when used wisely, while overleveraging can endanger an empire

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Now imagine it only uses P20 million of its own cash and borrows the remaining P80 million at 6% interest. The firm has to pay around P19 million a year to pay off the loan’s combined principal and interest in five years. That leaves around P11 million of the annual P30 million profit flowing to investors. Over five years, that comes to roughly P55 million. It also results in a significantly better IRR of 47%.

The IRR makes the comparison sharper: around 15% in the all-equity scenario versus 47% with leverage. Same project and operating cash flow; the only difference is where the money came from. That’s the power of financial leverage. The answer is risk. As much as leverage boosts potential returns, it also magnifies potential losses. Debt comes with fixed obligations. Interest payments must be met, no matter what. If revenues slump, or if a recession ruins the market, lenders don’t wait.

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