Question

Suppose your company needs $20 million to build a new assembly line. Your target debt−equity ratio is 0.80. The flotation cost for new equity is 9 percent, but the flotation cost for debt is only 6 percent. Your boss has decided to fund the project by borrowing money because the flotation costs are lower and the needed funds are relatively small.

a. What is your company’s weighted average flotation cost, assuming all equity is raised externally?(Round your answer to 4 decimal places. (e.g., 32.16))

Flotation cost %
b. What is the true cost of building the new assembly line after taking flotation costs into account? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.(e.g., 32)

Answer 1

a) Weighted average cost-$1,320,000

b) True cost of building -$21,320,000

Step-by-step explanation:

The weighted average flotation cost is the average of the flotation cost weighted using the debt-equity proportion.

a) Weighted average cost

Weighted average flotation cost (%)

= (6%× 0.8) + (9% × 0.2) = 6.6%

Weighted average cost in dollar= 6.6%× 20 = $1,320,000

b) True cost of building

The true cost of the building is the sum of the cost of the building and the flotation cost

=$1,320,000 + $20,000,000

= $21,320,000

=