Salinas, Smith & Silguero Corporation is financing an ongoing construction proje

Question

Salinas, Smith & Silguero Corporation is financing an ongoing construction project. The firm will need $2,000,000 of new capital during each of the next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 60% debt and 40% equity, and it wants to be at that structure in 3 years, when the project has been completed. Debt flotation costs for a single debt issue would be 2.6% of the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt would be 3.5% of the gross amount. Ignoring time value effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in 3 separate issues?

Explanation / Answer

if they raise total debt capital present the total cost is 2.6% of the total funds.

if they raised 3 times in 3 years the cost is going to be 3.5% of the total debt value.

the needed capital is $2,000,000

debt is 60% in that. That is $1,200,000

the total cost if it raise one time = $3,120,000

if it raises 3 times then the cost= $4,200,000

if it raise one time the benefit would be $1,080,000

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