Task1. Touring Enterprises, Inc., has a capital structure consisting of $18 million in long-term debt and $7 million in common equity. There is no preferred stock outstanding. The interest rate paid on the long-term debt is 10%. The firm is in the 35% tax bracket. On the common equity (stock), the Company pays an annual dividend of $1.20 and expects to increase the dividend by 5% per year. The market price of the stock is $50.
Based on this detailed information, give answer of the following questions:
i) Evaluate Touring Enterprises' weighted average cost of capital (WACC).
ii) Work as follows: first, evaluate the after-tax cost of debt and then evaluate the cost of equity. Cite both formulas, and demonstrate all your work.
iii) Find out the weightings of debt and equity in the capital structure.
iv) Using your answers to the above questions, evaluate the WACC.
v) If Touring Enterprises were to increase the percentage of debt in its capital structure, what would happen to the WACC? No calculation is necessary- simply provide a concise, non-numeric response.
vi) Determine and explain the benefits and risks of debt financing. A two-paragraph answer will suffice.