Question

Halifax Technologies primarily relies on 100% equity financing to fund projects. A good opportunity is available that will require $250,000 in capital. The Halifax owner can supply the money from personal investments that currently earn an average of 8.5% per year. The annual net cash flow from the project is estimated at $30,000 for the next 15 years. Alternatively, 60% of the required amount can be borrowed for 15 years at 9% per year. Using a before-tax analysis and setting the MARR equal to the WACC, determine which plan, if either, is better.

Answer 1

100% equity financing from personal investments is better

Step-by-step explanation:

100% equity financing option.

Expected annual return on the project = $30,000

Lost investment opportunity = 8.5% * 250,000 = $21,250.

Therefore incremental return from 100% equity financing option = $30,000 - $21,250 = $8,750 annually.

60% debt and 40% equity financing option.

Expected annual return on the project = $30,000

Lost investment opportunity = 8.5% * 40% * 250,000 = $8,500.

Interest rate on debt = 9% * 60% * 250,000 = $13,500.

Therefore incremental return = $30,000 - $8,500 - $13,500 = $8,000 annually.

Since the 100% financing gives a higher return than the debt-equity option, the 100% financing option is better.