Southern Alliance Company needs to ralse $23 milllon to start a new project and

Question

Southern Alliance Company needs to ralse $23 milllon to start a new project and will ralse 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, 8 percent preferred stock, and 22 percent debt Flotation costs for Issuling new common stock are 12 percent, for new preferred stock, 5 percent, and for new debt, 3 percent. What is the true Inltial cost figure Southern should use when evaluating its project? (Do not round your intermediate calculations.)

Explanation / Answer

Weighted average floatation cost=Respective costs*Respective capital structure

=(0.7*12)+(0.08*5)+(0.22*3)=9.46%

Hence true initial cost for evaluating the project=$23million/(1-Weighted average cost )

=$23,000,000/(1-0.0946)

which is equal to

=$25,403,136.74(Approx).

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