Homework: The Angel Investor
In this homework, you will be assessed based on the following Course Outcome:
o 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 homework 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:
a. Explain the tax benefits of debt financing.
b. Calculate the AT-WACC with a 60% debt and 40% equity financing structure.
c. Apply the calculated AT-WACC to explain why this is or is not a viable investment for you as the angel investor.
d. Explain a financial restructuring AT-WACC (given changes to proportions of % debt versus % equity financing) that would create a positive ROI.
e. 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.
f. 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.
Format your homework according to the give formatting requirements:
a. The answer must be double spaced, typed, using Times New Roman font (size 12), with one-inch margins on all sides.
b. The response also includes a cover page containing the title of the homework, the course title, the student's name, and the date. The cover page is not included in the required page length.
c. Also include a reference page. The references and Citations should follow APA format. The reference page is not included in the required page length.