Assignment
I am an angel investor who an entrepreneur has approached 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, the angel investor began negotiations saying he wanted the transaction to be financed with 50% debt and 50% equity.
As the angel investor, you assign a cost of equity of 14% and a cost of debt at 10%. 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 refinancing model for Year 2. You will use an after-tax weighted average cost of capital (AT- WACC) model, including the after-tax cost of debt and proportionate costs of debt versus equity. A 32% marginal tax rate is applied.
A. Explain the tax benefits of debt financing.
B. Calculate the AT-WACC with a 50% debt and 50% 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 percent debt versus percent 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.