Question

ABC Company has $700,000 in equity and $1,200,000 in debt. The CFO has determined that the flotation cost of equity is 2.5% and the flotation cost of debt is 3.5%. The company needs $3,000,000 for a company project.

What is ABC’s weighted average flotation cost? _______________

What is the amount the bank will have to raise to cover the company’s needs and its own fees? __________________

Answer 1

We = Weight of equity = 700,000/(700,000 + 1,200,000)

We = 0.3684210526

Wd = Weight of debt = 1,200,000/(700,000 + 1,200,000)

Wd = 0.6315789474

Weighted average flotation cost = 0.3684210526 * 0.025 + 0.6315789474 * 0.035

Weighted average flotation cost = 0.03131578947

Weighted average flotation cost = 3.131578947%

The amount the bank will have to raise to cover the company’s needs and its own fees = 3,000,000 * (1 + 0.03131578947)

The amount the bank will have to raise to cover the company’s needs and its own fees = $3,093,947.36841