Southern Alliance Company needs to raise $24 million to start a new project and

Question

Southern Alliance Company needs to raise $24 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 70 percent common stock, 11 percent preferred stock, and 19 percent debt. Flotation costs for issuing new common stock are 12 percent, for new preferred stock, 8 percent, and for new debt, 3 percent. What is the true initial cost figure Southern should use when evaluating its project? (Do not round your intermediate calculations.)

$22,160,000

$26,622,296

$27,687,188

$26,364,000

$25,557,404

Southern Alliance Company needs to raise $24 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 70 percent common stock, 11 percent preferred stock, and 19 percent debt. Flotation costs for issuing new common stock are 12 percent, for new preferred stock, 8 percent, and for new debt, 3 percent. What is the true initial cost figure Southern should use when evaluating its project? (Do not round your intermediate calculations.)

Explanation / Answer

$24 mil is the total capital required by Southern Alliance.

Let us look at the components:

70% Common Stock of $24 mil = $16,800,000.. Adding floatation cost of 12% = $16,800,000 * (1 + 12%) = $18,816,000

11% Preferred Stock of $24 mil = $2,640,000.. Adding floatation cost of 8% = $2,640,000 * (1 + 8%) = $2,851,200

19% Debt of $24 mil = $4,560,000.. Adding floatation cost of 3% = $4,560,000 * (1 + 3%) = $4,696,800

Hence, total capital = $18,816,000 + $2,851,200 + $4,696,800 = $26,364,000. Answer

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