Touring Enterprises, Inc., has a capital structure consisting of $18 million in

Question

Touring Enterprises, Inc., has a capital structure consisting of $18 million in long-term debt and $7 million in common equity. There is no preferred stock outstanding.

The interest rate paid on the long-term debt is 10%. The firm is in the 35% tax bracket.

On the common equity (stock), the Company pays an annual dividend of $1.20 and expects to increase the dividend by 5% per year. The market price of the stock is $50.

Based on this information, answer the following question:
Identify and explain the benefits and risks of debt financing.

Explanation / Answer

Please rate :))

If the company were to increase the debt that the WACC will reduce as the cost of debt is lower compared to cost of equity Benefits of Debt: Since the interest paid on debt is tax deductible, the cost of debt is lower due to tax savings. Hence, employing debt in the capital structure to some extent will increase the return to the equity holders. Funding via debt does not entail dilution of equity(which would be the case if the funds were financed by additional equity issue) and voting power of the stockholders. Risk: Too much debt in a company increases risk. Hence, the cost of debt may increase as the investors may require higher return for their funds. Debt is a liability of a company and has to be repaid before anything gets distributed to the equity stock holders. Creditors can claim some or all assets for non compliance of the terms of the loan.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.