P14-19 Calculating Flotation Costs [L04] Southern Alliance Company needs to rais

Question

P14-19 Calculating Flotation Costs [L04]

Southern Alliance Company needs to raise $28 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 has a target capital structure of 70 percent common stock, 10 percent preferred stock, and 20 percent debt. Flotation costs for issuing new common stock are 9 percent, for new preferred stock, 6 percent, and for new debt, 5 percent. What is the true initial cost figure Southern should use when evaluating its project?(Do not round your intermediate calculations.)

Southern Alliance Company needs to raise $28 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 has a target capital structure of 70 percent common stock, 10 percent preferred stock, and 20 percent debt. Flotation costs for issuing new common stock are 9 percent, for new preferred stock, 6 percent, and for new debt, 5 percent. What is the true initial cost figure Southern should use when evaluating its project?(Do not round your intermediate calculations.)

Explanation / Answer

Let the total euity to be raised be X,

Common Stock to be raised= X*0.6*0.85

Prefered Stock to be raised= X*0.1*0.93

Debt to be raised = X*0.3*0.94

Threfore according to problem,

(X*0.6*0.85)+(X*0.1*0.93)+(X*0.3*0.94) = $28 m
0.885 X = $28 m
? X = $28 m/0.885

X = $31638418.079

Therefore capital raised to be is $31638418.079

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