Suppose your company needs $17 million to build a new assembly line. Your target

Question

Suppose your company needs $17 million to build a new assembly line. Your target debt-equity ratio is 0.83. The flotation cost for new equity is 10 percent, but the flotation cost for debt is only 4.5 percent. Your boss has decided to fund the project by borrowing money, because the flotation costs are lower and the needed funds are relatively small.

(a)
Your company's weighted average flotation cost is _____ percent.
(Round your answer to 2 decimal places.)

(b)
The true cost of building the new assembly line after taking flotation costs into account is $_________
(Round your answer to the nearest whole dollar amount.)

Explanation / Answer

D/E = 0.83 --> D = 0.83E Total value, V= D+E = 1.83E E = V/1.83 = 0.546V, E/V=0.546 D/V=1-E/V = 0.454 (a) WACC = 0.546*10%+0.454*4.5% = 7.50% (b) Debt Financing = $17million*0.454 = $7.72 million Interest on debt = $7.72 million * 4.5% = $0.35 million True cost = $17million + $0.35 million = $17.35 million

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