Suppose your company needs dollar 16 million to build a new assembly line. Your

Question

Suppose your company needs dollar 16 million to build a new assembly line. Your target debt-equity ratio is .6. The flotation cost for new equity is 12 percent, but the flotation cost for debt is only 9 percent. Your boss has decided to fund the project by borrowing money because the flotation costs are lower and the needed funds are relatively small. What is your company's weighted average flotation cost, assuming all equity is raised externally? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Floating cost______% What is the true cost of building the new assembly line after taking flotation costs into account? (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.)

Explanation / Answer

a.Weighted average flotation cost = sum of product of weight*corresponding flotation cost

=0.6/(1+0.6)*9+1/(1+0.6)*12

=10.87%

b. True cost = cost + debt/(debt+equity)*cost*cost of debt + + equity/(debt+equity)*cost*cost of equity

=16+0.6/(1+0.6)*0.09*16+1/(1+0.6)*0.12*16

= 17740000

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