Question

Southern Alliance Company needs to raise $25 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 50 percent common stock, 8 percent preferred stock, and 42 percent debt. Flotation costs for issuing new common stock are 11 percent, for new preferred stock, 6 percent, and for new debt, 6 percent. What is the true initial cost figure Southern should use when evaluating its project? (Do not round your intermediate calculations.)

A.$27,125,000

B.$26,229,508

C.$27,322,404

D.$23,083,333

E.$28,415,300

Answer 1

Southern Alliance Company
What is the true initial cost figure Southern should use when evaluating its project?
We first need to find the weighted average floatation cost. Doing so, we find:
f T = 0.50(0.11) + 0.08(0.06) + 0.42(0.06) = 0.085 or 8.5%
And the total cost of the equipment including floatation costs is:
Amount raised(1 – 0.085) = $25,000,000
Amount raised = $25,000,000/(1 ? 0.085) = $27,322,404