MT480-6: Incorporate the combined attributes of debt and equity given a cost of capital model. The concept of after-tax

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MT480-6: 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 assignment 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:
Checklist: