Question

FoodMart is considering a project. The project's flotation costs amount to 9.2% of the funding need. Thus, the project analysis should Multiple Choice Increase the project's discount rate to offset these expenses by multiplying the company's WACC by 1.092 0 O increase the project's discount rate to offset these expenses by dividing the company's WACC by (1 - 092) 0 ) add 9.2 percent to the company's firm's WACC to determine the discount rate for the project 0 increase the initial project cost by multiplying that cost by 1.092 0 increase the initial project cost by dividing that cost by (1 - 092)

Answer 1

1. The correct formula to incorporate floatation costs in cost of project is

Initial Cost of project (with floatation costs) = Initial Cost of project (without floatation cost) / ( 1- floatation cost %)

Hence, the correct option is Option 5

2. From the above formula, we can say that floatation costs increase the initial cash outflow of project. However, we can still properly evaluate the project. It decreases the NPV and rate of return of project and thus Option 4 is correct

3. If all the common stock is bought by a group, their required return is called the Cost of equity (Option 2)

4. Cost of equity is generally higher than after tax Cost of Debt and WACC because of riskiness of equity cashflows. Also, it is directly related to market risk premium . Since it is directly related to the risk of the firm , correct option is No. 3