Question

A company is considering a project which has an initial startup cost of $787,050. The firm maintains a debt-to-equity ratio of 1.15. The flotation cost of debt is 8.66% and the flotation cost of external equity is 12.86%. The firm has sufficient internally generated equity to cover the equity cost of this project. What is the initial cost of the project including the flotation costs?

$802,919

$823,507

$844,095

$864,682

$885,270

Answer 1

Solution:

Debt to equity ratio=1.15.It means total amount to be raised is 2.15(Debt+Equity)

Thus portion of debt is;

=($787,050/2.15)*1.15

=$420980.23

Portion of equity is;

=$787,050-$420980.23=$366,069.77

Since,firm has sufficient internally generated equity to cover the equity cost of this project.Hence equity portion will not involve flotation cost.Thus,initial cost of the project including the flotation costs is;

=Equity Portion+Debt Portion(1+flotation cost)

=$366,069.77+$420980.23(1+0.0866)

=$823506.89

Thus correct answer is $823,507