Question

Southern Alliance Company needs to raise $70 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 60 percent common stock, 15 percent preferred stock, and 25 percent debt. Flotation costs for issuing new common stock are 12 percent, for new preferred stock, 9 percent, and for new debt, 2 percent. What is the true initial cost figure the company should use when evaluating its project ?

Answer 1

$88,832,487.31

Explanation:

According to the scenario, computation of the given data are as follow:-

FT = flotation cost of new debt percent × target capital debt percent + flotation cost of new common stock percent × target capital common stock percent + flotation cost of new preferred stock percent × target capital preferred stock percent

= 0.02 × 0.25+ 0.12 × 0.60 + 0.09 × 0.15

= 0.005 + 0.072 + 0.135

= 0.212

Now

True initial cost

= $70 million ÷ ( 1 - 0.212)

= $70 million ÷ 0.788

= $88,832,487.31