Sarah Scott borrowed $200,000 from a bank to start a catering business and has a

Question

Sarah Scott borrowed $200,000 from a bank to start a catering business and has agreed to pay the bank $15,000 per year in interest expense.

1. What is the cost of debt for Sarah ?

2. If Sarah raises another $100,000 of equity from her sister Allison, agrees to give her a 25% ownership posiyion in her catering business, and projects annual cash flow before debt to be $50,000, what is Sarah's cost of equity ?

3. What is the weight of debt for Sarah's catering business ?

4. What is the weight of equity for Sarah's catering business ?

5. If Sarah's business falls in the 30% tax bracket, what is her cost of debt after tax?

Show formulas please. Thank you

Explanation / Answer

interest Expense      15,000.00 Loan      200,000.00 Cost of debt =Interest/Loan *100 7.50% Equity      100,000.00 Annual cash flow before debt      50,000.00 Interest      15,000.00 Earnings for equity shareholders      35,000.00 Allison's share(25%)        8,750.00 Cost of equity= Allison's share/Equity from Allison                 0.09 Loan      200,000.00 Equity      100,000.00    300,000.00 Weightof debt=200,000/300,000                 0.67 Weightof Equity=100,000/300,000                 0.33 interest Expense      15,000.00 Loan      200,000.00 Cost of debt =Interest/Loan *100 7.50% Cost of debt =7.5%(1-Tax rate)                 5.25

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