Disadvantage of High Gearing Level
High Default Rate
The risk of default increase at high level of gearing .Company
may not be able to pay the interest , the high interest payment may reduces the
profit drastically and company has higher chances of liquidation as compared to
low gearing companies.
1.Tax Exhaustion
Debt finance results in tax saving but this benefit limited
to the profitability of the business , if the business profit convert into
business loss due to high interest payment then the tax benefit associated with
the interest is no more available.
2.Borrowing Capacity Reduces
The borrowing capacity reduces at high level of gearing due
to default risk. The debt holder is no more interested to borrow the high
geared company due to high default risk. The debt holder is interested in
regular interest payment on their debt which is at risk in high geared company.
3.Low Investor Confidence
The investor has low confidence on high geared company
because financial risk if mainly born by the equity holder and therefore the
equity holder avoid investment in high geared company. The high geared company
may not be able to pay the regular dividend due to high interest payment.
