Suppose your company needs $11 million to build a new assembly line. Your target
ID: 2765199 • Letter: S
Question
Suppose your company needs $11 million to build a new assembly line. Your target debtequity ratio is .35. The flotation cost for new equity is 7 percent, but the flotation cost for debt is only 4 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? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
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, e.g. 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.)
Suppose your company needs $11 million to build a new assembly line. Your target debtequity ratio is .35. The flotation cost for new equity is 7 percent, but the flotation cost for debt is only 4 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.
a.What is your company’s weighted average flotation cost, assuming all equity is raised externally? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.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, e.g. 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.)
Explanation / Answer
Answer 1 Debt Equity ratio = 0.35 Funds needed = $11 million Debt = ($11 million * 35) /135 = $2.85 million Equity = $11 million - $2.85 million = $8.15 million Total in $ Million Weight Flotation cost Multiplication A B A * B Debt 2.85 0.26 0.04 0.0104 Equity 8.15 0.74 0.07 0.0519 11 1.00 0.0622 Weighted average flotation cost = 0.0622 i.e. 6.22% Answer 2 Cost of building after taking into account floatation cost Total in $ Million Flotation cost Flotation cost In % In $ Debt 2.85 4% 0.114 Equity 8.15 7% 0.5705 11 0.6845 True cost of building assembly line = $11 million + $0.6845 million = $11.6845 million True cost of building assembly line = $1,16,84,500
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