Question

Cal Poly Corporation would like to start a new project: building a high-tech rose float for the next regional contest. This rose float project will require $35,000 in the initial cost. The company is planning to raise this amount of money by selling new corporate bonds and new stocks. It has a target capital structure of 40 percent common stock, and 60 percent debt. Flotation costs for issuing new common stock is 7%, and for new debt it is 4%.

(a) The true required initial investment that Cal Poly Corporation should use in its valuation of the rose float project is  #1#2#3#4. (Increase decimal places for any intermediate calculations, from the default 2 to 6 or higher. Only round your final answer.)

#1	$36,920
#2	$36,820
#3	$35,000
#4	$33,180

(b) TRUE OR FALSE? The lower the flotation costs, the lower the initial investment that needs to be used in project valuation, and so the lower the project's Net Present Value. This statement is  #1#2#3#4.

#1	TRUE
#2	FALSE

1 points   

Answer 1

a

Weight of Equity = 0.4

Weight of Debt = 0.6

Flotation cost of Capital = Weight of Equity*Flotation cost of Equity+Weight of Debt*Flotation cost of Debt

Flotation cost of Capital = 7*0.4+4*0.6

Flotation cost of Capital = 5.2

True cost = initial investment/(1-flotation cost %) =  35000/(1-0.052)
=36920

b

False,

Lower flotation cost will reduce initial investment which will increase NPV