This process refers to the source of funds to finance the investment cost, and capital structure typically consists of share equity, loans, and grants. For example, investment costs can be financed by (50%) of loans and equity. Many determents influence the decision of the capital structure, including the cost of money, management control, and risk tolerance. Loans incur interest expenses, and share equity promises investment returns to investors. The weighted average cost of capital (WACC) results from the weighted cost of loans and equity. (WACC) impacts the project viability as it is oppositely correlated to profitability.
Step-By-Step Process
- Evaluate the components of the investment costs (e.g., net working capital and fixed assets), founders’ risk tolerance, expected profit returns, and business plans and objectives.
- Clarify the investment costs and explore options for financing.
- Using multi-methods to fix a capital structure, including the cost of capital, profitability, cash flows, and WACC might be considered a key determent for the capital structure.
- Collect information about credit conditions and costs from lending houses.
- Explore the returns and risk tolerance potential investors claim to invest in the business.
- Set the ideal capital structure, and calculate the WACC and expected return on investment.
- Test and validate the capital structure options regarding capital cost, returns, risk, control, cash flows, and overall profitability.
- Share a discussion of the capital structure with your team and experts and obtain advice.
Example
Here is the capital structure projection of a pharmaceutical manufacturing facility:
| Capital | Construction Yr. 1 | Yr. 1 | Yr. 2 | Yr. 3 |
| Loans | 21,316,614 | 21,316,614 | 21,316,614 | 21,316,614 |
| Additional loans | – | – | 1,000,000 | 1,000,000 |
| Accumulated repayments of loans | – | – | – | (2,231,661) |
| Net Loans | 21,316,614 | 21,316,614 | 22,316,614 | 20,084,953 |
| Paid-up capital (Equity) | 7,105,538 | 7,105,538 | 7,105,538 | 7,105,538 |
| Additional paid-up capital | – | – | – | – |
| Net profit/loss | – | (4,702,848) | (5,488,660) | (435,382) |
| Retained profit | – | (4,702,848) | (10,191,508) | (10,626,891) |
| Pay-out dividends % | – | – | – | – |
| Pay-out dividends $ | – | – | – | – |
| Sub. Total | 7,105,542 | 2,402,694 | (3,085,966) | (3,521,349) |
| Total | 28,422,168 | 23,719,320 | 19,230,660 | 16,563,615 |
Useful Tips
- Study the capital structure in line with the business plans, cash flow requirements, cost of capital, target profitability, and control.
Things To Avoid
- Use your judgement only without sharing discussions with the team and experts.
- Avoid guesswork and assumptions without evidence.
Final Note
This article is sourced from my new book- Your Guide For Preparing An Industrial Feasibility Study.
For more information about the book: https://growenterprise.co.uk/book-your-guide-for-preparing-an-industrial-feasibility-study/
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Or email us at: maldawood@growenterprise.co.uk
The author: Munther Al Dawood- Industrial Enterprise Expert
Grow Enterprise 