P14-19 Calculating Flotation Costs [LO4] Southern Alliance Company needs to rais

Question

P14-19 Calculating Flotation Costs [LO4] Southern Alliance Company needs to raise $25 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 50 percent common stock, 9 percent preferred stock, and 41 percent debt. Flotation costs for issuing new common stock are 13 percent, for new preferred stock, 5 percent, and for new debt, 5 percent. What is the true initial cost figure Southern should use when evaluating its project? (Do not round your intermediate calculations.) O$26,373,626 $27,250,o00 O $28,571,428 $27472,527 o $23,083,333

Explanation / Answer

Weighted average cost of floatation=Respective costs*Respective weights

=(0.5*13)+(0.09*5)+(0.41*5)

=9%

Hence true intial cost figure for evaluating the project=$25million/(1-Weighted average cost of floatation)

=$25,000,000/(1-0.09)

which is equal to

=$27,472,527(Approx).

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