WACC Bender

Initial Investment = $450,000

The Present Value = -$457,630

Net Present Value= -$672,409

Payback = $1,130,039

Annual Depreciation costs = $90,000/year

It appears that Bender should not go ahead with this expansion as they will appear to lose nearly $130,000 on this investment. The net present value decision suggests that this project does not stand to make any significant amount of money. If the facility could somehow be salvaged at the end of five years, this move would make more sense .

WACC = E/V x Re + D/V x Rd x (1 - Tc)

Re = cost of equity

Rd = cost of debt

E = market value of the firm's equity

D = market value of the firm's debt

V = E + D = firm value

E/V = percentage of financing that is equity

D/V = percentage of financing that is debt

Tc = corporate tax rate

Touring WACC = 7.48%

If Touring were to increase its percentage of debt the WACC would continue to rise.

Financing an organization with debt financing can be very risky and dangerous, but there are also advantages if it is done right and with a little help from the market rates. Debt financing includes such things as long-term loans, so there is always some sort of risk that goes along with this type of procedure. When used properly 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.

Care must be taken before taking on this sort of commitment. 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.

References

Fundamentals of Corporate Finance, 10th edition.

Year 1

Year 2

Year 3

Year 4

Year 5

$80,000

-$450,000

$100,000

$120,000

$140,000

$165,000

Cash Flow Diagram, Bender Guitar Corp