Flotation Costs Suppose in the previous problem Watta is seeking $30 million for a new project. The necessary funds will have to be raised externally.

Question

Flotation Costs Suppose in the previous problem Watta is seeking $30 million for a new project. The necessary funds will have to be raised externally. Watta’s flotation costs for selling debt and equity are 2 percent and 16 percent, respectively. If flotation costs are considered, what is the true cost of the new project?

Accepted Answer

Because Watta uses both debt and equity to finance its operations, we first need the weighted average flotation cost. As in the previous problem, the percentage of equity financing is 2/3, so the weighted average cost is:

[latex]f_{A}=(E/V)×f_{E}+(D/V)×f_{D}[/latex]

=2/3×16%+1/3×2%

=11.33%

If Watta needs $30 million after flotation costs, then the true cost of the project is $30 million/[latex](1-f_{A})[/latex]=$30 million/.8867=$33.83 million.

Question 14.S-T.3: Flotation Costs Suppose in the previous problem Watta is see...

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