What is the primary purpose of debt in a capital structure?

The primary purpose of debt in a capital structure is to enhance total returns. When a company utilizes debt, it can leverage its capital, meaning it can use borrowed funds to invest in projects or assets that are expected to generate returns greater than the cost of the debt. This approach amplifies the potential return on equity (ROE), as the gains from these investments benefit equity holders after covering the debt obligations.

Using debt strategically can lead to a higher return on investment, provided that the generated returns exceed the interest costs associated with the debt. This concept is fundamental in real estate finance, where leveraging properties through mortgages can enhance overall profitability.

Minimizing cash flow is not the central role of debt; rather, effective debt management aims to optimize cash flow by allowing for greater investment opportunities. Debt does not prioritize equity investors directly; instead, it can create a balance in the capital structure that fosters growth for equity holders. While improving liquidity ratios can be a byproduct of better cash management due to borrowed funds, it is not the primary function of debt within the capital structure.