Question

A company is considering a project which has an initial startup cost of $783,534. The firm maintains a debt-to-equity ratio of 1.10. The flotation cost of debt is 8.45% and the flotation cost of external equity is 12.63%. 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? $797,759 $818,215 $838,670 $859,125 $879,581

Answer 1

Weight of debt = Debt equity ratio / (1 + debt equity ration)
= 1.10 / (1 + 1.10)
= 1.10 / 2.10
= 0.5238

Weight of equity = 1 - 0.5238 = 0.4762

Weighted average of flotation cost = (weight of debt * flotation cost of debt) + (weight of equity * flotation cost of equity)
= (0.5238 * 8.45%) + (0.4762 *0%)
= 4.4261% + 0%
= 4.4261%

Initial cost of project including flotation costs = Initial cost * (1 +flotation cost)
= $783,534 * (1 + 0.1044)
= $818,215

Initial cost of project including flotation costs = $818,215