Goodbye, Inc., recently issued new securities to finance a new TV show. The proj

Question

Goodbye, Inc., recently issued new securities to finance a new TV show. The project cost $14.7 million, and the company paid $795,000 in flotation costs. In addition, the equity issued had a flotation cost of 77 percent of the amount raised, whereas the debt issued had a flotation cost of 3.7 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the company's target debt-equity ratio? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g. 32.1616.) Debt-equity ratio eBook & Resources eBook 13 11 Flotation Costs and the Weighted Average Cost of Gaptal Check mv work

Explanation / Answer

1. For Goodbye Inc. assume that the debt portion in new issue of the company is X and equity portion is Y

Therefore X +Y = $14.7 Million

Or X = $14.7 Million – Y                    …………………………….. (1)

And total flotation cost is $795,000, where flotation cost for debt is 3.7% and for equity 7.7%; this can be written in following manner

X *3.7% + Y*7.7% = $795,000

Now putting the value of X from equation (1), we get

($14.7 Million – Y)* 3.7% + Y*7.7% = $795,000

Or $14.7 Million *3.7% – Y* 3.7% + Y*7.7% = $795,000

Or $543,900 + Y*(7.7%-3.7%) =$795,000

Or Y *4% =$795,000 -$543,900 = $251,100

Or Y = $251,100 /4% = $6,277,500 (equity portion of the company)

Therefore Debt portion of company X = $14,700,000 – $6,277,500 = $8,422,500

And Debt –equity ratio = Debt /Equity = $8,422,500/$6,277,500 = 1.3417

2. For Trower crop.

a. The initial cost of the plant if the company raises all equity externally

Total cost of plant is $111 million

Flotation cost of equity is 8.1% to raise fund externally

Therefore Initial cash flow = Total cost of plant + flotation cost

= $111 million +$111 million* 8.1%

=$111,000,000 + $8,991,000

=$119,991,000

b. The initial cost of the plant if the company typically uses 65% of retained earnings means 65% fund have no flotation cost and assume that rest 35% raises through equity externally

Therefore,

Initial cash flow = Total cost of plant + flotation cost on 35% of fund

= $111 million +$38,850,000* 8.1%

=$111,000,000 + $3,146,850

=$114,146,850

c. The initial cost of the plant if the company typically uses 100% of retained earnings means no flotation cost for company

Therefore,

Initial cash flow = Total cost of plant

= $111 million

=$111,000,000

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