Question

Comedy, Inc. has a debt-equity ratio of 0.54. The firm is analyzing a new project which requires an initial cash outlay of $430,000 for equipment. The flotation cost is 8.6 percent for equity and 5 percent for debt. What is the initial cost of the project including the flotation costs?

Answer 1

Let equity be 1 .Debt equity ratio =Debt /equity

                 .54 = Debt /1

                 Debt = .54*1 =.54

Total debt and equity = 1+.54 =1.54

Average Flotation cost = [F equity * weight of equity ]+ [F debt * weight of debt]

        =[8.6 * 1/1.54]+ [5 * .54/1.54]

        = 5.58442+ 1.75325

       = 7.33766%

Initial cost =purchase cost/(1-Flotation cost]

        = 430000/(1-.0733766)

         = 430000 / .92662

         = $ 464052.15 [rounded to 464052]]