Southern Alliance Company needs to raise $55 million to start a new project and

Question

Southern Alliance Company needs to raise $55 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 70 percent common stock, 15 percent preferred stock, and 15 percent debt. Flotation costs for issuing new common stock are 9 percent, for new preferred stock, 6 percent, and for new debt, 2 percent.

What is the true initial cost figure the company should use when evaluating its project? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.)

Southern Alliance Company needs to raise $55 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 70 percent common stock, 15 percent preferred stock, and 15 percent debt. Flotation costs for issuing new common stock are 9 percent, for new preferred stock, 6 percent, and for new debt, 2 percent.

Explanation / Answer

Answer Step-1 Equity=0.70 Preferred=0.15 Debt=0.15 Average Floating Costs= (0.70*9)+(0.15*6)+(0.15*2) Answer: 7.5% Divided with 100 (7.5/100) 0.075 Step-2 Initial Cost- Including Floatation cost= (Raise Amount/(1- Average Floating Costs)) ($55,000,000/(1-0.075)) $                                                                  59,459,459.46 It is a perpetuity, so we devide by(1- average floatation cost). Step-3 (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.) So our answer will be $59,459,459. The after point figure of .46 will not be rounded off as it is less than .50

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