MT480M6-6: Incorporate the combined attributes of debt and equity given a cost of capital model.
The concept of after-tax weighted average cost of capital (WACC) is a foundation when assessing cost of capital and investment options. The assessment will present the opportunity to assess a financing transaction and build upon your understanding of this cost of capital concept and demonstrate your ability to calculate the after-tax WACC.
Read the scenario and address the checklist items below.
Scenario: You are an angel investor who has been approached by an entrepreneur to assess an investment opportunity.
An entrepreneur asks for $100,000 to purchase a diagnostic machine for a healthcare facility. The entrepreneur hopes to maintain as much equity in the company as possible, yet as the angel investor, you require the transaction to be financed with 60% debt and 40% equity.
As the angel investor, you assign a cost of equity of 16% and a cost of debt at 9%. Based on Year 1 sales projections, the entrepreneur assures you a return on investment (ROI) of 9%; conceptually this will cover the first year’s pretax cost of debt and allow for planned equity growth and a refinancing model for Year 2. You will use an after tax weighted average cost of capital (AT- WACC) model which includes the after-tax cost of debt and proportionate costs of debt versus equity. A 35% marginal tax rate is applied.
Address the following checklist items:
- Explain the tax benefits of debt financing.
- Calculate the AT-WACC with a 60% debt and 40% equity financing structure.
- Apply the calculated AT-WACC to explain why this is or is not a viable investment for you as the angel investor.
- Explain a financial restructuring AT-WACC (given changes to proportions of % debt versus % equity financing) that would create a positive ROI.
- Explain why you as the angel investor would require more or less debt versus equity financing. Be sure to note the role of the Unified Commercial Code-1 (UCC-1) document in this transaction and the order of claim on assets in times of a bankruptcy.
- Include a strong thesis statement, introduction, and conclusion. The main points of the response should be developed and explained clearly with appropriate financial and accounting terminology.
Minimum Submission Requirements
- Your paper must be in a minimum 2-page APA formatted, and include a title page and reference page.
- You must use at least one scholarly, high quality, and current Purdue Global Library source in addition to your course materials. Peer-reviewed academic articles, articles published in journals, textbooks, and library resources found in the “ProQuest ABI/Inform Collection” database from the Library are examples of high-quality resources.
- Parrino, R., Kidwell, D. S., Bates, T., & Gillan, S. L. (2017). Fundamentals of Corporate Finance (4th ed.). Wiley Global Education US. https://purdueuniversityglobal.vitalsource.com/books/9781119371434
- Chapter 13: “The Cost of Capital”
- Please let me know if you need additional resources
- Parrino, R., Kidwell, D. S., Bates, T., & Gillan, S. L. (2017). Fundamentals of Corporate Finance (4th ed.). Wiley Global Education US. https://purdueuniversityglobal.vitalsource.com/books/9781119371434
- Be sure to include references for all sources and cite them using in-text citations where appropriate. Use your textbook, the Library, and/or the Internet for research.
- Your paper submission should:
- include a title page;
- be double-spaced;
- be typed in Times New Roman, 12-point font; and
- be free of spelling or punctuation errors.
