Your company is considering a project that will cost $100. The project will gene

Question

Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10% and the firm's D/A ratio is .70. The flotation cost for equity is 6%, the flotation cost for debt is 3%, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the weighted-average flotation cost for the firm?

Explanation / Answer

HI,

Please find the detailed answer as follows:

Proportion of Debt in Capital Structure = 70%

Proportion of Equity in Capital Structure = 30% (1-70%)

Weighted Average Floatation Cost = Proportion of Debt in Capital Structure*Debt Floatation Cost + Proportion of Equity in Capital Structure*Equity Floatation Cost = .70*3 + .30*6 = 3.90%

Option B (3.90%) is the correct answer.

Thanks.

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