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Tangible unencumbered fixed assets serve as a collateral security to debt.

In the event of any unforeseen financial distress, the creditors can have recourse to these assets and they may be able to recover their debt by foreclosing such assets. Companies with large tangible assets will have very less financial distress and costs and they will be preferred by the creditors. Companies with intangible assets will not have any such advantages Non debt and debt tax shields The tax provisions provide for deduction of interest paid on debt and therefore the debt capital can increase the companys after tax free cash flows. Therefore this interest shield increases the value of the company. This tax advantage of debt implies that companies will employ more debt to reduce tax liabilities and increase value. In practice this is not always true as is evidenced from many empirical studies. Companies also have non debt tax shields like depreciation, carry forward losses, etc. This implies that companies that have larger non debt tax shields would employ low debt as they may not have sufficient taxable profit to have the benefit of interest deductibility. However, there is a link between non debt tax shields and the debt tax shields because companies with higher depreciation would tend to have higher fixed assets, which serve as collateral against debt Financial flexibility Companies will normally have a low level of threat or insolvency perception even though their cash and funds flows are comfortable. Despite this, the companies may exercise conservative approach in their financial leverages since the future is very much uncertain and it may be difficult to consider all possible scenarios of adversity. It is therefore prudent for the companies to maintain financial flexibility as this will enable the companies to adjust to any change in the future events. Loan agreements The creditors providing the debt capital would insist for restrictive covenants in the long term loan agreements to protect their interest.

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