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 55 percent common stock, 15 percent preferred stock, and 30 percent debt. Flotation costs for issuing new common stock are 7 percent, for new preferred stock, 4 percent, and for new debt, 2 percent.

What is the true initial cost figure Southern should use when evaluating its project?

Explanation / Answer

Floatation Cost = 55%*7% +15%*4% + 30%*2% = 5.0500%
Floatation cost = 5.0500%*$55 million = 2.777500 million

true initial cost figure Southern should use when evaluating its project = $55million +2.7775 million = $57,777,500

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