Question

Explain all in detail and support your argument using the financial concepts that are consistent with the book.

1. What are flotation costs and why must they be included in the initial cost of a project? Explain in detail.

Answer 1

ANS: Flotation cost are incurred by the publicly traded company when it issues new securities & incurr expenses like underwriting fees, Legal fees, Registration fees etc.Foltation cost are generally less for the debt and the preferred issues

Flotation cost are incurred while company is raising additional capital & the value of flotation cost are material cost & it shall be prudent to add the flotation cost in the Initial cost of project. It generally increases the cost of equity.

The Formula for the cost of equity = [Do(1+g) / Po * (1-F)] + g (here, F is the flotation cost)

Project's initial cost refers to the expenses incurred for Design, construction, planning etc. So, In order to calculate the total initial cash outlay, we have to add flotation cost in the project's initial cost.