Southern Alliance Company needs to raise $22 million to start a new project and

Question

Southern Alliance Company needs to raise $22 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 e target capital structure of 55 percent common stock, 11 percent preferred stock, and 34 percent debt. Plotation costs for issuing new common stock are 14 percent, for new preferred stock, 7 percent, and for new detbt, 4 percent. What is the true initial cost figure Southern should use when evalueting its project? (Do not round your intermediate calculations) $24,362.600 O $24.398.359 O $23422.425 O $20166667 O$25.374.293

Explanation / Answer

Solution:-

Ans:- True initial cost = $24,398,359

Calculations:-

First need to find the weighted average floatation cost.

The weighted average flotation cost can be calculated as follows :-

Weighted average flotation cost

            =Fc*Wc+ Fp*Wp+ Fd*Wd

Where

Fc =Flotation cost of common stock= 14%

Wc = Weight of common stock=0.55

Fp=Flotation cost of preferred stock= 7%

Wp= Weight of preferred stock= 0.11

Fd=Flotation cost of debt = 4%

Wd = Weight of debt = 0.34

Substituting the values we get

Weighted average flotation cost

= 14%*0.55 + 7%*0.11 + 4%*0.34

=7.7%+0.77%+1.36%

= 9.83%

The true cost of the equipment including floatation costs is

=Amount raised(1 – 0.0983) = $22,000,000

Amount raised = $22,000,000/(1 ? 0.0983)

Amount raised = $22,000,000/0.9017

                             =$24,398,359

Please feel free to ask if you have any query in the comment section.

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