Question

Emma and Jorge are partners owning a Laundromat business. They are looking to expand soon but disagree on how to pay for the expansion. Emma believes they should wait to earn enough to pay for the expansion entirely while Jorge thinks they should take out a loan for the full amount today. Provide an example of how they could negotiate to invent options for mutual gains.

Answer 1

It is a capital structure decision. A Healthy debt to equity ratio must be maintained in order to maximize profits.

Debt to Equity ratio = Total Debt/ shareholders capital.

Is there an easily identifiable debt-equity ratio that will maximize the value of a firm/profits?

There is no such clearly identifiable debt to equity ratio.

The Typical debt to equity ratio must be less than 1 for most industries.
However, it changes from industry to industry. For an industry which is asset-heavy like automobiles, power generation the debt to equity of higher than 1 is considered normal. It has a typical debt to equity to be less than 2.5 (it should be compared with companies in the same industry to arrive at the figure - a changes from country to country).

The debt to equity ratio must be in check to the industry standards. The company should not take more debt than it can chew. Because many growth companies fail because of not able to service the debt.

Typical debt to equity ratio also changes taking economic conditions into consideration. If the economy is booming a higher debt to equity is acceptable. whereas, when the economy is the same debt becomes a curse and destroys shareholders value. Hence a minimal debt to equity is expected during a recession.

Hence the laundromat business company should take loan taking into consideration:
1. The Industry Standard.
2. It's own ability to pay.
3. The current and forecasted economic conditions.  

Given the current information:
Debt to equity ratio of 1 (approximately) looks ideal.

Borrow half funds & Invest half money.