Southern Alliance Company needs to raise $30 million to start a new project. The

ID: 2701904 • Letter: S

Question

Southern Alliance Company needs to raise $30 million to start a new project. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 50 percent common stock, 11 percent preferred stock, and 39 percent debt. Flotation costs for issuing new common stock are 9 percent, for new preferred stock, 7 percent, and for new debt, 2 percent. What is the true initial cost figure Southern should use when evaluating its project?

HINT: Since the company generates no Retained Earnings, all of the project will be financed externally. Calculate the weighted average floatation cost. Use this number to figure out how much money the company must pay to issue the new securities. Remember that the total amount raised, net of the financing cost, must leave the company with exactly $30 million to start the project. This financing cost must be added to the start-up cost of the project to get the true, total cost.

$30,654,604 $31,931,879 $31,815,000 $28,200,000 $33,209,154

Explanation / Answer

= 0.50(0.09) + 0.11(0.07) + 0.39(0.02) =0.0605

Amount raised =(1-0.0605)=50 000 000

Amount raised =50 000 000 /(1-0.0605)= 53219797.76

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Southern Alliance Company needs to raise $30 million to start a new project. The

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