Western Wear is considering a project that requires an initial investment of $26

Question

Western Wear is considering a project that requires an initial investment of $260,000. The firm maintains a debt-equity ratio of .40 and has a flotation cost of debt of 8 percent and a flotation cost of equity of 10.5 percent. The firm has sufficient internally generated equity to cover the equity portion of this project. What is the initial cost of the project including the flotation costs?

Western Wear is considering a project that requires an initial investment of $260,000. The firm maintains a debt-equity ratio of .40 and has a flotation cost of debt of 8 percent and a flotation cost of equity of 10.5 percent. The firm has sufficient internally generated equity to cover the equity portion of this project. What is the initial cost of the project including the flotation costs?

Explanation / Answer

Weight of Debt = 0.4/1.4 = 28.57%

Let the initial cost for the project including flotation cost be x

Amount of Debt Required for the project = 28.57% * x

Floataion cost of debt = 8% * 28.57% * x

x - (8% * 28.57% * x) = 260000

x - 0.022856x = 260000

0.977144x = 260000

x = 260000/0.977144 = $266,082

Initial cost of the project including the flotation costs = $266,082

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