You are evaluating a project that requires $324,000 in external financing. The flotation cost of equity is 8.4 percent and the flotation cost of debt is 5.1 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of .35?

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You are evaluating a project that requires $324,000 in external financing. The flotation cost of equity is 8.4 percent and the flotation cost of debt is 5.1 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of .35?

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andromache andromache · Answer 1 · 2025-03-30T17:10:06-04:00

Answer:

$350,438.65

Explanation:

For computation of initial cost of the project first we need to follow some points which is shown below:-

Point 1

Weight of Debt = Debt ÷ (Debt + Equity)

or

= (Debt ÷ Equity) ÷ ((Debt + Equity) ÷ Equity)

= 0.35 ÷ (0.35 + 1)

= 0.259259

Weight of equity = 1 - Weight of debt

= 1 - 0.259259

= 0.740741

Point 2

Weighted average flotation cost = (Flotation cost of debt × Weight of debt) + (Flotation cost of equity × Weight of equity)

= 5.1% × 0.25926 + 8.4% × 0.74074

= 0.013222 + 0.62222

= 0.075444

or

= 7.54%

and finally

Initial cost = External financing ÷ (1 - Average flotation cost)

= $324,000 ÷ (1 - 0.075444)

= $324,000 ÷ 0.92455556

= $350,438.65