Assignment: The Angel Investor
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 the cost of capital and investment options. The assignment will present the opportunity to assess a financing transaction, 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 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.
Address the following checklist items.
1) Weighted Average Cost of Capital (WACC)
a) Explain the tax benefits of debt financing.
b) Correctly calculates the AT-WACC with a 60% debt and 40% equity financing structure.
c) Applies the calculated AT-WACC to explain why this is or is not a viable investment for the Angel Investor.
2) Restructuring and Analysis
a) Explain a financial restructuring AT-WACC (given changes to proportions of percent debt versus percent equity financing) that would form a positive ROI. (Explains what the entrepreneur's financial restructuring (% Debt and % Equity) needs to be in order to form a positive ROI.)
b) 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. (Discusses UCC filings and how they protect borrowers during bankruptcy.)
3) Intro & Conclusion
a) 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.