Lorre, Inc., recently issued new securities to finance a new TV show. The projec

Question

Lorre, Inc., recently issued new securities to finance a new TV show. The project cost $13.7 million, and the company paid $695,000 in flotation costs. In addition, the equity issued had a flotation cost of 6.7 percent of the amount raised, whereas the debt issued had a flotation cost of 2.7 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 debt–equity ratio? (Do not round intermediate calculations and round your final answer to 4 decimal places. (e.g., 32.1616))

Explanation / Answer

The total floataion cost as a percentage of the project cost is 695,000/13,700,000 = 0.05073 = 5.073%

Let X be the amount of equity and (1-X) be the amount of debt

X*6.7 + (1-X)*2.7 = 5.073

6.7X + 2.7 - 2.7X = 5.073

4X = 2.373

X = 0.59325

Equity = 0.59325

Debt = 1- 0.59325 = 0.40675

Hence Debt to equity ratio = 0.40675/0.59325 = 0.6856

Debt-to-equity ratio = 0.6856

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