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Explain the tax benefits of debt financing

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Reference no: EM132483476

Scenario: You are an Angel Investor who has been approached by an entrepreneur to assess an investment opportunity.

Point 1: 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.

Point 2: 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:

Question 1: Explain the tax benefits of debt financing.

Question 2: Calculate the AT- WACC with a 60% debt and 40% equity financing structure.

Question 3: Apply the calculated AT-WACC to explain why this is or is not a viable investment for you as the Angel Investor.

Question 4: Explain a financial restructuring AT- WACC (given changes to proportions of % Debt vs. % Equity financing) that would indicate a positive ROI.

Question 5: 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.

Reference no: EM132483476

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