Question

Caughlin Company needs to raise $55 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 55 percent common stock, 15 percent preferred stock, and 30 percent debt. Flotation costs for issuing new common stock are 7 percent, for new preferred stock, 4 percent, and for new debt, 2 percent.

What is the true initial cost figure the company should use when evaluating its project?

Answer 1

Total cost to raise a net amount of 55,000,000 at our target capital structure = $57,925,224

Step-by-step explanation:

Based on the target capital structure we solve for a weighted average of the flolation cost:

weight flotation cost weighted average

Equity 55% 7% 3.85%

Debt 30% 2% 0.60%

Preferred 15% 4% 0.60%

5.05%

Now we apply this average flotation cost to our desired net raise amount:

55,000,000 / (1 - 0.0505) = 57,925,224