Suppose you are the CEO of a shipping company and have an extra dollar to spare. Would you pay down debt or would you return the dollar to shareholders?
I believe that paying down debt is the better choice, especially in a cyclical industry like shipping where weak markets are the norm, and they can happen at any time.
As you can see from the case study, when you return cash to shareholders (either through dividends or stock-buybacks), you effectively increase your leverage by raising the net debt to capitalization ratio.
The higher the leverage, the harder – and more expensive – would be to borrow during a down cycle.
Paying down debt should be your top priority, until you reach a leverage target that allows for prompt & low-cost borrowing.
In our next lesson we will explore the best way to return cash to shareholders, once the leverage target is achieved.
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