Caughlin Company needs to raise $70 million to start a new project and will rais

Question

Caughlin Company needs to raise $70 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, 15 percent preferred stock, and 15 percent debt. Flotation costs for issuing new common stock are 10 percent, for new preferred stock, 7 percent, and for new debt, 2 percent.

What is the true initial cost figure the company should use when evaluating its project? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount, e.g., 32.)

Initial cost: $_________

Caughlin Company needs to raise $70 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, 15 percent preferred stock, and 15 percent debt. Flotation costs for issuing new common stock are 10 percent, for new preferred stock, 7 percent, and for new debt, 2 percent.

What is the true initial cost figure the company should use when evaluating its project? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount, e.g., 32.)

Initial cost: $_________

Explanation / Answer

Calculation of true initial cost of the new project:

Before calculating the initial cost , we need to know the Weighted average Floating cost

that means, Weighted average floating cost = sum of capital structure * floating cost

= (70% * 10%) + (15% * 10%) + (15% * 2%)

= 0.7*0.1 + 0.15*0.1 + 0.15*0.02

=0.07 + 0.015 + 0.003 = 0.088 = 8.8% is the Weighted average floating cost.

Total cost of equipment including floating costs => true initial cost (1-.8.8%) = 70million

true initial cost = 70million / (1-.8.8%)

true initial cost = 70million / (1-.0.088)

true initial cost = 70million / 0.912

true initial cost = 76,754,385.96

Therefore, true initial cost  = $76,754,386 (rounded off)

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.