{"id":4141,"date":"2026-07-30T06:00:44","date_gmt":"2026-07-30T04:00:44","guid":{"rendered":"https:\/\/maraz.es\/?p=4141"},"modified":"2026-07-29T22:25:25","modified_gmt":"2026-07-29T20:25:25","slug":"financial-debt-that-maximizes-firm-value","status":"publish","type":"post","link":"https:\/\/maraz.es\/en\/financial-debt-that-maximizes-firm-value\/","title":{"rendered":"Can Financial Debt increase your company’s value? Optimal Capital Structure"},"content":{"rendered":"

Financial Debt and its impact on valuation: The \u201cZero-Debt\u201d Myth<\/strong><\/h2>\n

In many family-owned businesses in the middle market<\/em>, there is an almost sentimental conviction: debt is a risk, and \u201cowing nothing to anyone\u201d is a sign of strength. It is an understandable instinct, but financial theory and the day-to-day practice of M&A tell a different story. A debt-free company is rarely the most valuable one. Used judiciously, debt lowers the cost of capital, multiplies the return to shareholders and, in a sale, can translate into a higher cheque.<\/strong><\/p>\n

This is not about taking on debt for its own sake, but about understanding why a well-thought-out capital structure is a value lever and not merely a source of risk. Let us look at it without unnecessary jargon, with a worked example and with the figures of the Spanish market in 2026.<\/strong><\/p>\n

Picture two identical companies: same assets, same profits, same sector. The only difference is that one is financed entirely with the owners\u2019 money and the other combines equity with a portion of bank debt. Intuition says the first is \u201cstronger\u201d. Financial reality says that, in an environment with taxes, the second is worth more. Why?<\/strong><\/p>\n

Because the owners\u2019 capital is the most expensive resource a company has<\/strong>. The shareholder is the last to get paid and, in exchange for that risk, demands a high return. Debt, by contrast, is cheaper: the bank gets paid first, takes on less risk and therefore settles for a lower interest rate. And there is a second, even more concrete reason: interest on debt is deductible in Corporate Income Tax. Dividends paid to shareholders are not.<\/p>\n

Financing the whole company with equity therefore means giving up a cheaper resource and a guaranteed tax advantage. \u201cZero debt\u201d carries an opportunity cost that is often invisible, but very real: lower returns for the owner and, as we will see, a valuation below what the company could achieve.<\/p>\n

The three ways debt creates value<\/strong><\/h2>\n

When we say debt \u201ccreates value\u201d, it is not a catchphrase: there are three concrete, measurable mechanisms.<\/strong><\/p>\n

1. The Tax Shield: The Tax Authority Funds Part of Your Interest<\/strong><\/h3>\n

Interest on debt is a deductible expense. With the general Corporate Income Tax rate at 25%, every euro of interest your company pays reduces its tax bill by 25 cents. This is what is known as the tax shield<\/strong>: part of the cost of the debt is, in effect, borne by the Tax Authority.<\/p>\n

This is why the real cost of debt is always lower than its nominal rate. A loan at 5% with a 25% tax rate has an effective cost of 3.75% (5% \u00d7 (1 \u2212 0.25)). That spread, applied year after year, is money that stays inside the company.<\/p>\n

2. A Lower WACC: The Company Is Worth More in a Discounted Cash Flow<\/strong><\/h3>\n

The value of a going concern is calculated, in essence, by discounting its future cash flows at a rate that reflects its risk. That rate is the weighted average cost of capital, the WACC<\/a>. The lower the WACC, the higher the present value of those flows and, therefore, the higher the company\u2019s value.<\/p>\n

Since debt is cheaper than equity \u2014and, on top of that, tax-deductible\u2014 adding a reasonable proportion of debt lowers the WACC. And a lower WACC translates, almost automatically, into a higher enterprise value<\/em>. This is the direct link between capital structure and valuation that is so often overlooked.<\/p>\n

3. The Leverage Effect: Greater Returns for the Owner<\/strong><\/h3>\n

The third mechanism is the best known and also the most misunderstood: the financial leverage effect<\/a>. The idea is simple: if the return your company earns on its assets exceeds the cost of debt, every euro financed with debt generates a surplus that flows straight into the shareholder\u2019s pocket. The result is a higher ROE (return on equity).<\/p>\n

It is a double-edged lever, and it is worth stating plainly from the outset: it amplifies profits when the business does well, but it also amplifies losses when it does badly. Let us see it with numbers.<\/strong><\/p>\n

A worked example: The same company, two structures<\/strong><\/h2>\n

Take two companies with identical assets of \u20ac10,000,000 and the same operating profit (EBIT) of \u20ac1,000,000 \u2014that is, a return on assets of 10%. Company A<\/strong> has no debt. Company B<\/strong> finances 40% of its assets with debt at 5%. The Corporate Income Tax rate is 25%.<\/p>\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n
\n

Financial item<\/strong><\/p>\n<\/td>\n

Company A (no debt)<\/strong><\/td>\nCompany B (with debt)<\/strong><\/td>\n<\/tr>\n<\/thead>\n
Total assets<\/td>\n\u20ac10,000,000<\/td>\n\n

\u20ac10,000,000<\/p>\n<\/td>\n<\/tr>\n

\n

Equity<\/p>\n<\/td>\n

\u20ac10,000,000<\/td>\n\u20ac6,000,000<\/td>\n<\/tr>\n
Financial debt (at 5%)<\/td>\n\u20ac0<\/td>\n\n

\u20ac4,000,000<\/p>\n<\/td>\n<\/tr>\n

\n

Operating profit (EBIT)<\/p>\n<\/td>\n

\u20ac1,000,000<\/td>\n\u20ac1,000,000<\/td>\n<\/tr>\n
\u2212 Interest<\/td>\n\u20ac0<\/td>\n\n

\u20ac200,000<\/p>\n<\/td>\n<\/tr>\n

\n

Profit before tax<\/p>\n<\/td>\n

\u20ac1,000,000<\/td>\n\u20ac800,000<\/td>\n<\/tr>\n
\u2212 Corporate Income Tax (25%)<\/td>\n\u20ac250,000<\/td>\n\n

\u20ac200,000<\/p>\n<\/td>\n<\/tr>\n

\n

Net profit<\/p>\n<\/td>\n

\u20ac750,000<\/td>\n\u20ac600,000<\/td>\n<\/tr>\n
Tax saving from debt<\/td>\n\u2014<\/td>\n\n

\u20ac50,000<\/p>\n<\/td>\n<\/tr>\n

\n

ROE (return on equity)<\/strong><\/p>\n<\/td>\n

7.50%<\/strong><\/td>\n\n

10.00%<\/strong><\/p>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

Look at what happens. Company B earns less in absolute terms (\u20ac600,000 versus \u20ac750,000), because it pays \u20ac200,000 in interest. And yet its owner obtains a far higher return: an ROE of 10% versus 7.5% for Company A. The key is that Company B needed \u20ac4 million less equity to run exactly the same business. That freed-up capital is what drives the shareholder\u2019s return higher.<\/strong><\/p>\n

On top of that, Company B saved \u20ac50,000 in taxes thanks to the deductibility of interest. That is the tax shield working in real life.<\/p>\n

The Other Side: What happens if the business turns sour<\/strong><\/h3>\n

Now suppose a bad year comes and EBIT falls 40%, to \u20ac600,000. In Company B, the \u20ac200,000 of interest is fixed: profits or no profits, it must be paid. Profit before tax drops to \u20ac400,000 and ROE collapses to 5%. In Company A, with no interest to pay, ROE would hold at 4.5%\u2026 but starting from a far more comfortable base.<\/p>\n

This is the uncomfortable but honest message: leverage amplifies in both directions. That is why the right question is not \u201cdebt: yes or no?\u201d, but \u201chow much debt can my business sustain without compromising its stability?\u201d. And that question is answered with data, not with hunches.<\/p>\n

How much debt Is \u201chealthy\u201d? The optimal point exists<\/strong><\/h2>\n

Debt creates value\u2026 up to a point. Beyond that threshold, the risk of financial distress starts to weigh more than the tax saving, banks and shareholders demand higher returns, the WACC rises again and value falls. Academics call this the trade-off theory<\/em>, and it draws a U-shaped curve: the company\u2019s maximum value is at the point where the WACC hits its minimum.<\/strong><\/p>\n

In Spanish market practice, the indicator everyone watches is Net Financial Debt to EBITDA<\/strong>. As a general benchmark:<\/p>\n