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Shor-term debt financing usually attracts lower interest rate. However, it is common to observe businesses finance...

Shor-term debt financing usually attracts lower interest rate. However, it is common to observe businesses finance with long-term debt. Is such behaviour irrational? Explain.

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Answer #1

Solution:

No, such behaviour is not irrational because businesses require funds for varied purposes which includes working capital for operations and funds for capital investments.

Businesses take short term loan for working capital requirement which can range from 4-6 months depending upon working capital cycle.

While for all other requirements businesses prefer long term financing as it gives sufficient duration to serve the loan.

To conclude, even though short term loan is cheaper it is also to be seen for what purpose it is going to be used because funding long term projects with short term debt would then be irrational.

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