Southern Star Company needs to raise $80 million to start a new project and will

Question

Southern Star Company needs to raise $80 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 50 percent common stock, 10 percent preferred stock, and 40 percent debt. Flotation costs for issuing new common stock are 12 percent, for new preferred stock, 9 percent, and for new debt, 4 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. Do not round intermediate calculations and round your answer to the nearest whole dollar, e.g. 1,234,567.)

True initial cost           $

Explanation / Answer

Weighted average floating cost = 0.5*0.12 + 0.1*0.09 + 0.4*0.04 = 0.0850 = 8.50%

Total cost of equitment = Initial cost*(1-0.085) = 80 million

Initial cost = 80000000/(1-0.085) = $87431693.99

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