Question

Being Human, Inc., recently issued new securities to finance a new TV show. The project cost $35 million, and the company paid $2.2 million in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation cost of 3 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

Answer 1

0.3727

Explanation:

From the given information

Total costs = Project cost + Flotation cost

Total costs = $35,000,000 + $2,200,000

Total costs = $37,200,000

Amount raised × (1 – fT) = Amount needed after flotation costs

$37,200,000 × (1 – fT) = $35,000,000

1 - fT = $35,000,000 / $37,200,000

1 - fT = 0.9409

fT = 1 - 0.9409

fT = 0.0591

wD + wE = 1

wD = 1 - wE

where;

wD = weight of debt

wE = weight of equity

WAFC = (wD × Debt's fT) + (wE × Equity's fT)

0.0591 = (wD × 0.03) + ( (1 - wD) × 0.07)

0.0591 = [wD × 0.03) + 0.07 - (wD × 0.07)

0.0591 - 0.07 = -(wD × 0.04)

-0.0109 = - (wD × 0.04)

wD = -0.0109 / -0.04

wD = 0.2715

wE = 1 - wD

wE = 1 - 0.2715

wE = 0.7285

The debt-equity ratio = wD / wE

The debt-equity ratio = 0.2715 / 0.7285

The debt-equity ratio = 0.3727