Question

Southern Alliance Company needs to raise $120 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 8 percent, for new preferred stock, 5 percent, and for new debt, 3 percent.

What is the true initial cost figure the company should use when evaluating its project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.)

Answer 1

$127,727,515

Step-by-step explanation:

Calculation to determine the true initial cost figure Southern should use when evaluating its project

First step is to find the weighted average flotation cost.

Weighted average flotation cost= .55(.08) + .15(.05) + .30(.03)

Weighted average flotation cost= .044+.0075+.009

Weighted average flotation cost= .0605*100

Weighted average flotation cost=6.05%

Now let determine the true initial cost figure

True initial cost figure=(1 – .0605) = $120,000,000

True initial cost figure = $120,000,000 / (1 – .0605)

True initial cost figure = $120,000,000 / .9395

= $127,727,515

Therefore the true initial cost figure Southern should use when evaluating its project is $127,727,515