Question

How should the acquisition of MPIS be financed, taking into account the issues of control, flexibility, income and risk? Cash flows from Stock Offering (in Million Dollars) Proceeds from Stock offering $ 125.025 Annual Dividend Payments $ (7.50) Every year forever PV of payouts $ (125.000) NPV $ 0.025 Notes: In case they finance with debt, Winfield (the company) would be able to enjoy the tax shield as a result of tax deductible interest expense, hence their effective cost of debt will be 4.225%. However, when financed with stock, the new stockholders will be entitled to perpetuity of $7.5M in dividends. Working out the net present values of the two scenarios as shown in the tables above, Debt financing becomes a favorable option to stock since it yields a higher NPV.

Answer 1

Answer:

Debt finance

Explanation:

advantages of the above are:

Lowers tax liability of the company

reduces board room squabbles that can arise from new stockholders

Based on investment appraisal techniques and on information given, a higher NPV portfolio will always be preferred by any investment manager except where other considerations are factored in the decision making.

Saves the cash outflow of $7.5mm dividend in perpetuity which can be deployed for other uses.

Once the debt is fully paid back, the interest (loan rental) becomes available to be deployed by the company. Usually, liquid(profitable) businesses prefer to borrow than using equity to finance acquisition. They trade on debt over equity.