Unit 8 Assignment Instructions

Assignment: The Angel Investor

The concept of after-tax Weighted Average Cost of Capital (WACC) is a foundation when assessing cost of capital and investment options. The Assignment 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.

The following course outcome is assessed in this Assignment:

MT480-6: Incorporate the combined attributes of debt and equity given a cost of capital model.

Read the scenario and address the checklist items.

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, yet the Angel Investor requires 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, the Angel Investor, 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 vs. Equity. A 35% marginal tax rate is applied.

Address the following checklist items:

Checklist:

• 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 vs. % Equity financing) that would create a positive ROI.
• Explain why you as the Angel Investor would require more or less debt vs. 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.
• Submit your response in a minimum of a 2-page APA formatted Microsoft^® Word^® document to the Dropbox with additional title and references pages.

ANSWER

The Angel Investor

The tax benefits of debt financing.

After-tax cost of Debt = (Pretax Cost of Debt) * (1 – charge rate)

A major benefit of debt financing is that the intrigue cost is charge deductible (Babenko, Bessembinder, & Tserlukevich, 2020). This means that in the event one pays $100 in the enthusiasm of his/her obligation, with a 35 % assessment rate, the expenses will be somewhere near $35. This implies that the actual expense of that obligation will be just $65. This extricates to:

After-tax cost of Debt = (Pretax Cost of Debt) * (1 – charge rate)

Calculation of the AT- WACC with a 60% debt and 40% equity financing structure.

The After-tax WACC is 9.90%. This is more prominent than the 8% speculated, implying that the venture is the most suitable. In this manner, there is a need to expand the sum, which is the rate for this situation, of obligation. This will bring down the WACC until the WACC is equivalent to or under 8%. Hence, this is a viable investment as the Angel investor, and the most suitable venture to get into.

Explain a financial restructuring AT- WACC

 WACC is dependent on another percentage of the debt. As it should be obvious, there is a need for at least an 82.3% debt before the WACC = gets to the equivalent to or lower than the ROI of 8%.

Why you, as the Angel Investor, would require more or less debt vs. equity financing.

As an investor, there is a need for more obligations subsidizing to bring down the WACC beneath the ROI. Generally, the speculations will last return nor exactly required by the speculators. The obligation holders gave the main case on the benefits of the organization. The obligation holders will be paid first by a residual estimation of the firm. After they are paid, then the value financial specialists will get anything that remains.

References

Babenko, I., Bessembinder, H., & Tserlukevich, Y. (2020). Debt Financing and Risk Management. Yuri, Debt Financing and Risk Management .