Equity and debt financing

Two fundamental aspects need to be considered when assessing the impact of the financial markets on the success of private equity investments. First, all financial markets are cyclical, and the supply and demand of financial products drive the availability, volumes, and pricing of equity and debt financing. Second, European and U S capital markets provide access to different investors and therefore different market conditions. In almost all cases, the US market provides higher volumes and more favorable conditions for equity and debt transactions. 

In general terms, the initial fixed capital investment and the minimum net working capital are covered by a mix of equity and long-term loans and additional net working capital from short- and medium-term loans or from positive net cash flow (equity). Within this structure, various combinations and permutations need to be considered related to cost of finance, financial flexibility, debt service, and taxation. Consideration should also be given to leasing, supplier credits, and other sources of finance. In all cases, a balance has to be struck between equity and debt finance. 

Cost of capital This is the dominant component of holding cost for products that do not become obsolete quickly. The appropriate approach is to evaluate the weighted-average cost of capital (WACC), which takes into account the required return on the firm s equity and the cost of its debt (see Brealey and Myers, 2000). These are weighted by the amount of equity and debt financing that the firm has. The formula for the WACC is... 

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