Simulation on capital financing for corporations and its credit exposure

Abstract

This article explores the risk and return performance of a company when practicing equity and debt financing. Monte Carlo simulation is used to reflect 10 years of quarterly returns for a company when choosing either debt or equity financing. For simulation purposes, the average risk and return indicators have been benchmarked to the profitability of Nestle Malaysia Bhd. Given the various scenarios simulated, the result highlights equity financing's ability to reduce credit risk exposure when returns are tied to company performance – an essential measure considering that debt caused the global economic collapse of 2007/2008 and that risk sharing in an equity financing system could help curb credit risk exposure. A Monte Carlo simulation with 5000 iterations shows that equity financing creates zero credit risk exposure even for companies with low profitability. For those seeking to promote long-term sustainability despite financial shocks, equity financing can thus be a viable alternative approach to financing – yet despite its ability to reduce credit risk exposure, it remains a less favoured method. This research suggests that a clear explanation of equity financing could be used to interest investors and companies in this approach to financing.