1) Additionally to tax shield offered by governments around world, debt has the lower required rate of return than equity - describe why this is so? Given inherent tax shield benefits why might we still come across 100% Equity financed firms? Why is it not common to see firms with tremendously large debt components in their capital structure? Is there the optimal ratio of debt to equity and if so what factors decide it? Why is it not suitable to estimate all potential projects based on firms WACC?
Requirements
The Meyer Company should arrange financing for its working capital needs for coming year. Meyer can (a) have a loan from its bank on simple interest basis (interest payable at the ending of loan) for one year at a 12% simple rate; (b) have a loan on 3-month renewable loan at the 11.5% simple rate; (c) have a loan on instalment loan basis at a 6.0% add-on rate with 12 end-of-month payments; or (d) get the required funds by no longer taking discounts and therefore increasing its accounts payable. Meyer buys on terms of 1/15, net 60. Determine the EAR of least expensive type of credit, supposing 360 days per year?