Question

Cully Company needs to raise $29 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 70 percent common stock, 10 percent preferred stock, and 20 percent debt. Flotation costs for issuing new common stock are 10 percent, for new preferred stock, 7 percent, and for new debt, 6 percent. What is the true initial cost figure Southern should use when evaluating its project? Multiple Choice $31,833,150 $33,106,476 $26,776,667 $30,559,824

Answer 1

A. $31,833,150

We first need to find the weighted average floatation cost. Doing so, we find:

f_T = 0.70(0.10) + 0.10(0.07) + 0.20(0.06) = 0.089 or 8.9%

And the total cost of the equipment including floatation costs is:

Amount raised(1 – 0.089) = $29,000,000

Amount raised = $29,000,000/(1 − 0.089) = $31,833,150