Question

•Your company is considering a project that will cost $1 million. Thefirm’s target D/E ratio is .6 The flotation cost for equity is 5%, and the flotation cost for debt is 3%. What is the flotation costs?

•fA=

Answer 1

Flotation cost for equity = 5 %

Flotation cost for debt = 3 %

Target D/E ratio = 0.6 which means when debt is of $ 0.6 , then equity is of $ 1

Hence, total capital assuming above debt =$0.6 and equity = $ 1, total capital = $ 0.6 +$ 1 = $ 1.6

Weight of debt in capital structure =Debt / Total Capital = $ 0.6 / $ 1.6 = 0.375

Weight of equity in capital structure = Equity / Total Capital = $ 1 / $ 1.6 = 0.625

Total flotation costs = Weight of Debt * Flotation cost of debt +  Weight of  equity * Flotation cost of equity

= 0.375 * 3 % + 0.625 * 5 %

= 1.125 % + 3.125 %

= 4.25 %