Question

Goodbye, Inc., recently issued new securities to finance a new TV show. The project cost $13.4 million, and the company paid $665,000 in flotation costs. In addition, the equity issued had a flotation cost of 6.4 percent of the amount raised, whereas the debt issued had a flotation cost of 2.4 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the company’s target debt–equity ratio? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Answer 1

Total amount to be raised is $13.4 million. Here let the amount raised through equity is x and the amount raised through debt is (13,400,000 - x).

Flotation cost = Equity Flotation cost + Debt Flotation cost

665000 = x*6.4% + (13400000 -x)*2.4%

665000 = 321600 + x*4%

Hence x = 8585000

Therefore, amount raised through equity is 8585000

amount raised through debt = (13400000-8585000) = 4815000

Here the company issued new securities in the same proportion as its target capital structure.

Hence target Debt - Equity Ratio is 4815000/8585000 = 56.0861 %