Question

Quality Machine Rental needs $1,900,000 for a capital project that has been approved by the board.  Quality’s...

  1. Quality Machine Rental needs $1,900,000 for a capital project that has been approved by the board.  Quality’s weighted average flotation costs are 2.23%.  What is the amount that the investment bank will have to raise for Quality in order to cover its capital needs and the fees?

Amount to Raise________________________

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Answer #1

Sol:

Capital requirement = $1,900,000

Weighted average flotation costs = 2.23%

Flotation cost is the cost which needs to be bear by the firms when it raises capital. It includes costs related to registration fees, government fees, underwriting fees, legal fees, etc. While raising the capital, firms needs to consider the impact of flotation cost on the borrowing.

We need to add weighted average flotation costs to determine the amount that investment bank will have to raise for Quality in order to cover its capital needs and the fees will be as follows:

Amount to be raised = Capital requirement / (1 - Weighted average flotation costs)

Amount to be raised = $1,900,000 / (1 - 2.23%)

Amount to be raised = $1,900,000 / 0.9777 = $1,943,336.40, rounded off to $1,943,336

Therefore Amount to be raised will be $1,943,336

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