P14-19 Calculating Flotation Costs [L04] Southern Alliance Company needs to rais

Question

P14-19 Calculating Flotation Costs [L04] Southern Alliance Company needs to raise $23 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 65 percent common stock, 11 percent preferred stock, and 24 percent debt. Flotation costs for issuing new common stock are 10 percent, for new preferred stock, 8 percent, and for new debt, 4 percent. What is the true initial cost figure Southern should use when evaluating its project? (Do not round your intermediate calculations.) O $21,313,333 O $24,089,025 O $24,918,200 O $26,096,443 O $25,092,734

Explanation / Answer

E.$25,092,734.

first let us know the weighted average cost of raising funds:

sum of [weights of sources * cost of finance]

[0.65*10%] + [0.11*8%] + [0.24*4%]

=>8.34%.

now,

the initial cost figure will be = amount to be raised / (1 - weighted cost of raising fund)

=> $23 million / (1-0.0834)

=>$25,092,734.

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