Risk Mitigation through Target Cost of Capital- A Prescriptive Analytic Quadratic Programming Model For Start-Ups

Abstract

The tie-break between risk and return is a long-term challenge for the risk practitioners. Optimizing between cost of capital and risk proxied by leverages viz., operating and financial leverages is the objective of this model building exercise. The leverages are providing incentives when the cost to the owners and to other stake-holders in terms of risk is pungent. This issue is very rampant among the start-up digipreneurs. To strike a tie between cost of capital, for which Weighted Average Cost of Capital (WACC) is substituted, and leverages, the Quadratic Programming (QP) tool has been utilized. In QP, single linear convex WACC constraint function is strategised with a maximum WACC when the objective quadratic function is utilized with an orientation of maximization. The purpose of this research paper is to bring out a risk mitigation model with high leverage in a given cost of capital. An application of this model will provide a decision support in the areas of determining capital structure, cost of capital, indifference point, risk assumption, and management of cost between leverages. This Model also helps to suggest strategies using sensitivity analytics as extension.