The Right Blend
Week 3 of Finance 325 required students to complete the simulation titled "Determining the Debt Equity Mix: The Right Blend." This simulation asked students to work through various stages of a newly started exotic coffee shop, while determining the right debt-equity combination and optimal Weighted Average Cost of Capital (WACC). Students were given ownership of an extremely popular coffee shop named, "El CafÃÂ©." The shop is located in the very diverse community of Minneapolis, Minnesota. Founded three years ago primarily using personal savings on a minimal budget, "El CafÃÂ©" has become quite profitable therefore, students were asked to consider a possible expansion into other areas of the city. In 2001, the city was designated a special economic zone and the governor announced zero taxes and a break on interest baring loans. This was a perfect time for the exploration of a possible citywide expansion followed by a multi-city expansion as well.
The first step in the process was to generate financing. Understanding that the level of competition and the number of competitors had increased approximately $400,000.00 for every two stores would need to be raised. Students were tasked with trying to find suitable sources for capital while selecting a debt-equity mix that minimized the Weighted Average Cost of Capital (WACC). The selection of a capital structure with 70 percent debt ratio allowed "El CafÃÂ©" to achieve the low WACC figure of 8.65 percent. Had the equity component been any higher the WACC would have been higher as well. This debt ratio also kept the overall debt for "El CafÃÂ©" in a very manageable range.
Step two of the simulation takes place in the year 2004 and required students to analyze the feasibility and possible financing options for a multi-city expansion. "El CafÃÂ©'s" goal was to accelerate...