Borrowing funds to finance expansion or modernization is a very positive strategy if the terms of the loan are not too burdensome. We certainly don’t want the interest rate to be too high. Perhaps more important, we want the benefits of the investments to be achieved before the debt becomes due. Many companies have experienced financial problems because their bank debts came due before their investment projects achieved their forecasted benefits. In such cases, when the loans come due, the company has yet to generate the cash flow needed to repay them and as a result finds itself in a very uncomfortable position. Often the term of the loan is more critical than the actual interest rate paid.

If a company can achieve an after-tax return on investment of 25 percent on a project that will reach fruition in three years, whether the cost of the money needed for that project is 9.0 percent or 9.5 percent is not going to change the decision to invest in the project as long as the loan has a maturity of more than three years. If the financing is a one-year bank loan, the company will not have the cash to repay it and may be forced to cut back the project and reduce expenses at exactly the wrong time (if it is unable to refinance the loan). So, while the cost of funds is important, you should focus on the repayment schedule, as well.

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