Rodney Ruxin\'s Legal Services is raising capital to open a new law office in so

Question

Rodney Ruxin's Legal Services is raising capital to open a new law office in southern California. The project has an initial start up cost of $752,995. The firm maintains a debt-equity ratio of 0.50 and has a flotation cost of debt of 6.8 percent and a flotation cost of equity of 11.4 percent. The firm has sufficient internally generated equity to cover the equity cost of this project. What is the initial cost of the project including the flotation costs (enter your response as positive number, i.e. initial investment of $1 million as 1000000)?

Explanation / Answer

Since debt equity ratio is 0.5 we can say that debt is 0.5 times of equity

Debt = 0.5* equity

If equity=1, then debt =0.5

Hence weight of equity is 1/1.5 = 0.6667 and weight of debt is 0.5/1.5 = 0.3333

Hence Equity portion of the inital investment is 0.6667*752995 = $502,021.77

Hence debt portion will be $250,973.23

COst of equity including floation costs will be 502021.77*(1+0.114) = 559,252.25

Cost o debt including floattation costs will be 250973.23 * (1+0.068) = 268,039.41

Hence total cost of the project including floatation costs will be 559252.25 + 268039.41 = $827,291.66

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