Question

The firm’s cost of capital decreases when they incur flotation costs.

Group of answer choices

True

False

Answer 1

this statement is false

the firm's cost of capital decreases when they incur flotation costs.

it can prove by the following equation

for example,

the expected dividend, D1=5

Current share price =$10

Flotation cost =5%

Growth rate = 10%

cost of equity no flotation cost=D1/P0 +g

=5/10 +10%

=60%

Cost of equity if flotation cost is there=D1/P0(1-f) +g

=5/10(1-5%) +10%

= 62.63%

It is clear that if flotation cos is there the cost of equity will increase. and the cost of capital also increases because of the Cost of capital = cost of debt + cost of equity.