What is Debt Overhang?
Debt overhang occurs when a company has so much debt that it cannot easily borrow more funds or invest in new projects, leading to financial distress and stunted growth.
Example of Debt Overhang
A company with $10 million in debt and no way to generate sufficient revenue to cover its obligations may face debt overhang, discouraging new investments.
How To Calculate Debt Overhang
Calculate the company’s debt-to-equity ratio and compare it to industry standards. High ratios often indicate debt overhang.
- Special Tip: Regularly monitor debt levels and maintain a balance between debt and equity to avoid debt overhang.
- Advantages
- Highlights potential financial distress.
- Encourages prudent financial management.
- Helps in making informed borrowing decisions.
- Disadvantages
- Can lead to reduced investment and growth.
- May increase the cost of borrowing.
- Can cause loss of investor confidence.
FAQs
What causes debt overhang?
Excessive borrowing, poor financial management, and declining revenues.
How can a company resolve debt overhang?
Restructuring debt, improving cash flow, and seeking equity financing.
Can debt overhang affect a company's stock price?
Yes, it can lead to reduced investor confidence and a lower stock price.
What is a good debt-to-equity ratio?
It varies by industry, but generally, a lower ratio indicates lower financial risk.
