Debt-Equity Mix Simulation Summary

According to the simulation, the Weighted Average Cost of Capital (WACC) considers the relative proportions and costs of the debt and equity components to give the overall costs of capital for a firm. In the first Scenario, the goal was to expand El Cafй into a citywide chain. It got a boost from the city being designated an economic zone by the state governor. The challenge was to raise adequate financing, and find reliable sources of capital. The approximate estimate was around 400,000. The objective was to select a debt-equity mix that minimized the WACC for El Cafй expansion plan. I had included an equity component in the capital structure, which ended up in a high WACC. What I learned from this was since the cost of equity was higher than the cost of debt, it would have been better to keep a debt component of at least 70 percent in the financing mix. I could have the loan interest loans offered by the state.

In the next scenario, El Cafй has had great success over the past four years, and Uncle Jorge wanted to expand to other cities. Their were different plans developed, but he would only invest if he could be provider of funds. Since their was not any investors showing interest, debt and Uncle Jorge seemed to be the only options. So the objective is to select the optimal expansion strategy for El Cafй by benchmarking the projected rates of return against the WACC. I had chosen the expansion strategy that has a projected rate of return that is higher than the WACC. What I learned was that a seven city expansion had an even higher rate of return. A business investment is financially justified only if the projected rate of return from the business is higher than the WACC of the capital investment.

In the following scenario, El Cafй has run into competition with El Cafй Inn. It threatens to gain control by buying out Uncle Jorge's stake in El Cafй. So the objective is to avoid a takeover by Cafй Inn. This required me to control at least fifty percent of El Cafй equity. I had decided to borrow money and buy back 30 percent of El Cafй equity from Uncle Jorge. What I learned was that the optimal solution would have been to borrow money to buyback at least 50 percent of my equity from Uncle Jorge.

WACC is your weighted average cost of capital. You use it to determine if you should spend money on. If the rate of return on your spending is less