Question

Caughlin Company needs to raise $55 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 55 percent common stock, 15 percent preferred stock, and 30 percent debt. Flotation costs for issuing new common stock are 7 percent, for new preferred stock, 4 percent, and for new debt, 2 percent. What is the true initial cost figure the company should use when evaluating its project? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount, e.g., 32.) Initial cost $

Answer 1

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

f_T = 0.55(0.07) + 0.15(0.04) + 0.30(0.02) = 0.0505 or 5.05%

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

Amount raised(1 – 0.0505) = $55,000,000

Amount raised = $55,000,000/(1 − 0.0505) = $57,925,224