Pardon Me, Inc., recently issued new securities to finance a new TV show. The pr

Question

Pardon Me, Inc., recently issued new securities to finance a new TV show. The project cost $13.8 million, and the company paid $705,000 in flotation costs. In addition, the equity issued had a flotation cost of 6.8 percent of the amount raised, whereas the debt issued had a flotation cost of 2.8 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the company’s target debtequity ratio? (Do not round intermediate calculations and round your final answer to 4 decimal places, e.g., 32.1616.)

Explanation / Answer

Let x be the gross value of equity raised and y be the gross value of debt raised 0.068x + 0.028y = 705000 (Floatation Cost) x - 0.068x + y - 0.028y = 13800000 or, 0.932x + 0.972y = 13,800,000 (Project Capital) From Floatation Cost equation, we have 0.028y = 705000 - 0.068x or, y = (705000 - 0.068x)/0.028 Using the value of y in project capital equation, we get 0.932x + ((705000 - 0.068x)/0.028)*.972 = 13,800,000 or, 0.932x + 24,473,571.43 - 2.360571x = 13,800,000 or, 1.428571 x = 10,673,571.43 or, x = $7,471,500 Using above value in 0.932x + 0.972y = 13,800,000 or, 0.932 * 7471500 + 0.972y = 13,800,000 or, 6963438 + 0.972y = 13,800,000 or, 0.972y = 6836562 or, y = $7,033,500 Debt Raised = 0.972y = $6,836,562 Equity Raised = 0.932x = $6,963,438 Debt Equity Ratio = 6836562/6963438 = 0.9818

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