Having the appropriate debt-equity mix is very important to the financial triumph of any pedigree. One must give careful context to the mix of debt and equity capital which your fundamental law is to have. Although debt finance is cheaper, obtaining such finance depends on your ability to repay. It may also demand significant security. One must also ensure that your organization is not excessively leveraged (i.e., the ratio of debt to equity is not too high).
I recently completed a simulation execution for FIN/325 titled Determining the Debt-Equity Mix. During the simulation I was given(p) the role of owner of a coffee shop and was interpreted through the various stages of the evolving business. During the different stages I was presented with situations where I had to respect different proportions and costs of debt and equity components so that I could crystalise investment decisions. The goal was to optimize the Weighted Average damage of Capital (WACC) for the business so that I could lead the business to success. Following are the situations that I encountered and the decisions that I made as well as the reasons why I made those decisions.
The depression portion of the simulation presented me with the challenge of expanding the business in a very competitive market.
In send to be fortunate at expansion I needed to use WACC as a benchmark to decide the optimal debt-equity mix. Finding the serious mix would help me minimize the WACC.
I chose 70% debt to 30% equity mix which helped me achieve the lowest possible WACC of 8.65 percent. Choosing a higher equity percentage would have increased the WACC comfortably and a higher debt would have over-leveraged the business. Being over-leveraged would have maybe caused lenders to seek a higher rate of return receivable to the increased risk.
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