Explain the tax benefits of debt financing

The Angel Investor

The concept of after-tax Weighted Average Cost of Capital (WACC) is a common issue when studying finance at all levels. The impact of taxes, applicable to most forms of financing is a key component of studies in the field of finance. The Assignment will present the opportunity to assess and build upon your knowledge of and ability to calculate the after-tax WACC and the cost of debt and equity.

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: As an Angel Investor you have been asked to assess an entrepreneur’s product and financing options. In your role as an Angel Investor you focus on one year at a time. The entrepreneur asks for $100,000 immediately to purchase a diagnostic machine for a healthcare facility. The entrepreneur hopes to be financed with 60% debt and 40% equity. As the entrepreneurs’ venture capital partner, you assign a cost of equity of 15% and a cost of debt at 10%. You require a Return on Investment (ROI) of 8%. You are using an After Tax Weighted Average Cost of Capital (AT- WACC) model. 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 what the entrepreneur’s financial restructuring AT- WACC (% Debt and % Equity) need to be in order to 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 nature of the claims 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.

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