Question

Suppose your company needs $14 million to build a new assembly line. Your target debt-equity ratio is .5. The flotation cost for new equity is 10 percent and the flotation cost for debt is 7 percent. Your boss has decided to fund the project by borrowing money because the flotation costs are lower and the needed funds are relatively small.

a. What is your company’s weighted average flotation cost, assuming all equity is raised externally? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b. What is the true cost of building the new assembly line after taking flotation costs into account? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.)

Answer 1

solution: a) Weighted average floatation cost= we *fe+wd+fd (1/1.5)*0.1+(0.5/1.5) *0.07 9.00% b) true cost cost of plant/(1-Weighted average floatation cost) 15,38 15 14000000/(1-0.09) working Note: calculation 1/(1+0.5) 1/1.5 weight of equity flotation cost of equity weig ht of debt flotation cost of debt we fe wd fd 10.0% 0.5/(1+0.5) 0.5/1.5 7.0%