Question

The Upper Tier has a current debt-equity ratio of .52 and a target debt-equity ratio of .45. The cost of floating equity is 9.5 percent and the flotation cost of debt is 6.6 percent. What should the firm use as their weighted average flotation cost?

a. 7.76%

b. 8.33%

c. 8.01%

d. 8.52%

e. 8.60%

Answer 1

Calculate weighted average flotation cost (WAFC) as follows: Equity Debt+Equity Debt --× x Flotation cost of debt+ x Flotation cost of Equi WAFC- Debt+Equity 0.31034 0.31034+0.6896 0.6896 0.31034+0.6896 6.6% I + x 9.5% WAFC- 2.0590+6.5590 8.6% Therefore, the WACF is 8.6% Therefore, the Option Eis correct Working note l Debt-0.45 Equity Debt 0.45E quity--(1) Debt+Equity 1-(2) Debt -0.45Equity from equation (1) put it in equation (2) 0.45Equity +Equity1 Equity - 145 Equity 0.6896 Then debt-0.45x 06896 -0.31034