Southern Alliance Company needs to raise $24 million to start a new project and

Question

Southern Alliance Company needs to raise $24 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, 11 percent preferred stock, and 39 percent debt. Flotation costs for issuing new common stock are 11 percent, for new preferred stock, 8 percent, and for new debt, 2 percent. The true initial cost figure Southern should use when evaluating its project is $ ??. (Do not include the dollar sign ($). Do not round the weighted average floatation cost. Round your answer to the nearest whole dollar amount. (e.g., 32))

Explanation / Answer

Amount to be raised by issue of BONDS = $ 24 m

Amount to be raised by issue of COMMON STOCK = (24/0.39)*0.50           = $ 30.77 m

Amount to be raised by issue of PREFERENCE STOCK = (24/0.39)*0.11

= $6.77 m

..

The true initial cost figure Southern should use when evaluating its project is = Floatation cost for issuing common stock + Floatation cost for issuing preferred stock + Floatation cost for issuing debt

= 24*0.11 + 30.77*0.08 + 6.77*0.02

= 2.64 + 2.4616 + 0.1354

= $5.237 m

=$5237000

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