Suppose your company needs $10 million to build a new assembly line. Your target

Question

Suppose your company needs $10 million to build a new assembly line. Your target debt-equity ratio is 0. 40. The flotation cost for new equity is 10 percent, but the flotation cost for debt is only 7 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. What is your company's weighted average flotation cost, assuming all equity is raised externally? (Round your answer to 2 decimal places, (e.g., 32.16)) Flotation cost__________% What is the true cost of building the new assembly line after taking flotation costs into account? (Enter your answer in dollars, not millions of dollars, i.e. 1, 234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.(e.g., 32) Amount raised $

Explanation / Answer

a. Target Debt Equity Ratio is 0.40. Hence, if we assume equity as X Debt is 0.40 X Total Funding required = $ 10 million Thus, X + 0.40 X = 10,000,000 Therefore, 1.40X = 10,000,000 or X = 7142857.143 $ Debt is 0.40 X $ 7,142,857 = 2857142.857 $ Weighted Average Flotation Costs Particulars of Capital Value Flotation Weighted Costs Value Equity 7142857.143 10% 714285.7 Debt 2857142.857 7% 200000 Total 10000000 914285.7 Weighted Average Flotation Cost = 9.14% b. True Cost of Building the Assembly Line = Funding required - Total Flotation Costs = $ 10,000,000 - $ 914,286 = $ 9,085,714

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