Debt-Equity Mix Simulation

Subject  > Businesss Research Papers  > Accounting

Having the appropriate debt-equity mix is very important to the financial success of any business. One must give careful consideration to the mix of debt and equity capital which your organization is to have. Although debt finance is cheaper, obtaining such finance depends on your ability to repay. It may also require significant security. One must also ensure that your organization is not too leveraged (i.e., the ratio of debt to equity is not too high). I recently completed a simulation exercise for FIN/325 titled Determining the Debt-Equity Mix. During the simulation I was given the role of owner of a coffee shop and was taken through the various stages of the evolving business. During the different stages I was presented ...

... debt payments. This would only delay the inevitable and possibly increase the debt as lenders may decide to charge higher rates. The concept of the simulation was to choose the correct mix of debt and equity to lower the WACC and/or increase the return that was encountered. I found that the WACC was certainly impacted by the decisions that I made. If I took large amounts of debt to lower the WACC, I encountered the threat of bankruptcy. If I chose the route of equity then I faced the threat of being taken over. The best solution was to find the best mix that optimized the capital structure and led me to a successful expansion venture. Overall,

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