Families’ willingness to undertake debt versus equity. Assume education is financed with a mix of debt (loans) and savings, and the yearly cost of interest on a student’s loans does not exceed deductible amounts. All interest paid will be tax-deductible. The payer is assumed to have a tax liability, and a family’s or individual’s credit has no influence on loan rates or availability.
In this discussion, we compare individuals’ and families’ willingness to undertake debt versus relying on equity (savings) in financing investment in an educational training or degree program to a firm’s decision to mix financing vehicles as it determines how to approach an upcoming project. We assume, for the purposes of this discussion, that a new tax policy will soon be passed that lowers the limit on deductibility of interest expense on student loans, increasing their effective cost to the borrower. Consider how this will influence educational decisions.
Families’ willingness to undertake debt versus equity
Review the introduction of Chapter 11, section 11.1, and p. 397 of Chapter 12 of our required text before you start.
Section 1: Comparing Personal and Corporate Finance
While comparing an individual or family investing in education to a firm investing in a project of any type, discuss what cost of capital means by comparing personal cost of capital with corporate cost of capital.
[Hint: See p. 367-367, 377, and 379-381 of our required textbook.]
Section 2: Choice of Financing Tools
Focusing on both tax issues and income issues, discuss how these factors influence whether debt or savings (equity) is a more viable option for the family and the firm.
[Hint: Consider deductibility in relation to cost of capital and required reading covering after-tax cost of debt. See p. 372 of required readings. With respect to income issues, recall that the risk premium required by investors is the reward an investor requires for taking on risk. See p. 339 of our required textbook. Also see p. 399 of your required text for information on Opportunity Costs.]
Please reply to two people. As you respond to peers, consider:
Does it surprise you to see that individuals and families weigh the Net Present Value (NPV) of project returns against financing costs? Why or why not?
While both firms and individuals and families consider costs of debt and equity in financing projects, are these calculations different?
Your responses should cover both qualitative aspects as well as analytical statements regarding asset valuation and risk.