Suppose your company needs $17 million to build a new assembly line. Your target debt-equity ratio is 0.81. The flotation cost for new equity is 9.5 percent, but the flotation cost for debt is only 4.5 percent.
What is your company’s weighted average flotation cost, assuming all equity is raised externally? (Round your answer to 2 decimal places. (e.g., 32.16))
|Weighted average flotation cost||%|
What is the true cost of building the new assembly line after taking flotation costs into account? (Round your answer to the nearest whole dollar amount. (e.g.,1,234,567))
Answer to Requirement 1:
Weighted Average Flotation Cost = Weight of Debt * Flotation
Cost of Debt + Weight of Equity * Flotation Cost of Equity
Weighted Average Flotation Cost = (0.81/1.81) * 4.50% + (1.00/1.81) * 9.50%
Weighted Average Flotation Cost = 7.26%
Answer to Requirement 2:
True Cost of Building * (1 - Weighted Average Flotation Cost) =
True Cost of Building * (1 - 0.0726) = $17,000,000
True Cost of Building * 0.9274 = $17,000,000
True Cost of Building = $18,330,817
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