The simulation that will be discussed in this paper concerns the decisions that a coffee shop's owner needs to make in order to expand their business. The name of the shop is El CafÃÂ© and in located in Minnesota. The owner has decided to expand the business because it is becoming profitable and expanding the business is the next logical step. There is a rich uncle that is willing to help the owner by allowing him to utilize his cash assets. Following will be a short discussion on the importance of weighted average cost of capital (WACC) and what impact WACC has on capital budgeting and structure.
For the first scenario the owner needs to raise $400,000 in adequate financing in order to expand operations by two shops. The scenario calls for a determination on whether to get a debt zero tax and low interest loan or to use the equity that Uncle Jorge has in the company.
The decision was made on the debt-equity mix to do 70% debt and 30% equity. With this decision we have achieved the lowest WACC of 8.65%. By doing so, it also allowed the company to not put too much leverage on the company with too much debt. Otherwise, the company would have a substantial part of earning by meeting the high debt obligations.
For the second scenario, four years have passed and the company is looking at expanding into other cities. Doing so would accelerate growth and create a market for the company. The decision that needs to be made is how many cities to expand into and which source of funding to use. The decision was made to expand to 7 cities with debt to ensure that the projected rate of return was higher than the WACC. Choosing all debt-financing lowered...