Pardon Me, Inc., recently issued new securities to finance a new TV show. The pr

Question

Pardon Me, 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 7.7 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 debtequity ratio?

Please answer, nothing was correct from the previous answers. Other people didn't need structure information. I applied these numbers to correct answers algorythms but got wrong answer somehow.

Explanation / Answer

Solution :- (1 - Percentage flotation cost) = 14.70 Million / (14.70 Million + 0.795 Million).

(1 - Percentage flotation cost) = 14.70 Million / 15.495 Million

(1 - Percentage flotation cost) = 0.9487 (approx)

  Percentage flotation cost = 1 - 0.9487

  Percentage flotation cost = 0.0513 i.e., 5.13 %

Percent flotation cost * (1 + debt-equity ratio) = Equity flotation cost + Debt flotation cost * Debt-equity ratio.

0.0513 * (1 + D / E) = 0.077 + 0.037 D / E (Let the target debt-equity ratio be denoted by D / E).

0.0513 + 0.0513 D / E = 0.077 + 0.037 D / E

0.0513 D / E - 0.037 D / E = 0.077 - 0.0513

0.0143 D / E = 0.0257

D / E = 0.0257 / 0.0143

D / E = 1.7972 : 1

Conclusion :- Target debt equity ratio = 1.7972 : 1 (approx)

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

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