Question

Frontier Corp. needs $14 million to build a new assembly line. The firm's target D/E ratio is 1/9. The flotation cost for new equity is 10 percent and the flotation cost for debt is 5%. What is the true cost of building the new assembly line after taking flotation costs into account?

14.74 million

14.94 million

15.33 million

15.47 million

15.51 million

Answer 1

Given about Frontier Corp,

It needs $14 million

D/E ratio = 1/9

So, Debt portion = 10% = 0.10*14 = $1.4 million

Flotation cost for debt = 5%

=> Fund raised in debt = Debt needed/(1-flotation cost) = 1.4/(1-0.05) = $1.47 million

Similarly, Equity portion = 90% of 14 = $12.60 million

Flotation cost for new equity = 10%

=> Fund raised using new equity = Equity needed/(1-Flotation cost) = 12.60/(1-0.1) = $14 million

So, Total fund raised = Fund raised using new equity + Fund raised using new Debt = 14 + 1.47 = $15.47 million

Option D is correct.