Angie Watts 1

Topics: Finance, Net present value, Corporate finance Pages: 9 (1271 words) Published: January 21, 2015
[Title Here, up to 12 Words, on One to Two Lines]Wheel Industries Consultant Report Argosy University
Professor Charlie Merritt
Financial Management | FIN401 A02 Company Information

Wheel Industries is considering a three-year expansion project, Project A. The project requires an initial investment of $1.5 million. The project will use the straight-line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million per year before tax and has additional annual costs of $600,000. The Marginal Tax rate is 35%. Wheel has just paid a dividend of $2.50 per share. The dividends are expected to grow at a constant rate of six percent per year forever. If the stock is currently selling for $50 per share with a 10% flotation cost, what is the cost of new equity for the firm? What are the advantages and disadvantages of using this type of financing for the firm? Cash Flow

D= expected dividend per share
P= current market price of share
+= expected growth rate in dividend
(2.50*1.06)/ (50*90%) +.06= 11.89%

Advantages Equity Financing: Debt financing allows you to pay for new buildings, equipment and other assets used to grow your business before you earn the necessary funds. This can be a great way to pursue an aggressive growth strategy, especially if you have access to low interest rates. Closely related is the advantage of paying off your debt in installments over a period of time. Relative to equity financing, you also benefit by not relinquishing any ownership or control of the business (Kokemuller, 2014)
Disadvantage The most obvious disadvantage of debt financing is that you have to repay the loan, plus interest. Failure to do so exposes your property and assets to repossession by the bank. Debt financing is also borrowing against future earnings. This means that instead of using all future profits to grow the business or to pay owners, you have to allocate a portion to debt payments. Overuse of debt can severely limit future cash flow and stifle growth (Kokemuller, 2014). Capital Structure

The firm is considering using debt in its capital structure. If the market rate of 5% is appropriate for debt of this kind, what is the after tax cost of debt for the company? What are the advantages and disadvantages of using this type of financing for the firm? After tax cost of debt

5*(1-.35) =3.25%
Advantages Debt Financing Utilization of Resources – When a business use debt to finance its operation, they got no option than to fully utilize their resources because they will have to pay back the debt and interest to their creditor. Short Term Needs – Debt finance can easily be secured on a short term bases. This make it very advantageous to the small business as finance of this type can easily be secured for short term business needs. Tax Advantage – Debt financing also offers tax advantage to business as interest is deductible for income tax purposes. No Future Lender Claims - Lenders has no direct claim on future earnings Disadvantages Small business to make regular monthly payments of principal and interest. M Failure to make payments on a loan, even temporarily, can adversely affect a small business’s credit rating and its ability to obtain future financing cost lenders provide severe penalties for late or missed payments...

References: Block, S. (2009). Foundations of Financial Management. Vital Source bookshelf version Retrieved from http://digitalbookshelf.argosy.edu/books/007-737696X/id/ch01
Neil Kokemuller (2014). The Advantages and Disadvantages of Debt and Equity Financing. Retrieved from http://smallbusiness.chron.com/advantages-disadvantages-debt-equity-financing-55504.html
Unknown (2014). WAAC and Capital Budgeting. Retrieved from http://www.ask.com/question/wacc-and-capital-budgeting
Cromwell (2014). Description of Capital Budgeting. Retrieved from http://smallbusiness.chron.com/description-capital-budgeting-15496.html
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