Let us say there is a great business you would like to set up that involves a return of 20% every year after expenses and taxes. What if I gave you two choices:
1) You put in Rs. 1,000 as your investment, in setting up a business that returns Rs. 200 per year.
2) You put in Rs. 200 and borrow Rs. 800. The business still generates Rs. 200 per year. You pay Rs. 80 as interest on the loan, and the remaining, or Rs. 120 is yours.
In the first case the return you get is 20%. Your capital is at stake so if the business slows down to a return of 5%, you'll only get Rs. 50 per year.
In the second case, you make a 60% return — Rs. 120, on Rs. 200 of your capital. Awesome? But if the business drops to a 5% return, you will end up getting Rs. 50, and you now have to pay interest of Rs. 80 — for which you have to shell out more money from your pocket. Effectively that whittles down your capital to Rs. 170 (Rs. 200 minus the 30 as excess of interest over profit)
In the second case, theRead More »from Leveraging Our Trust