Question

Suppose your company needs $12 million to build a new assembly line. Your target debt−equity ratio is .5. The flotation cost for new equity is 12 percent, but the flotation cost for debt is only 9 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.)

Weighed average flotation cost %

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. Do not round intermediate calculations and round your answer to the nearest whole dollar, e.g. 1,234,567.)

True cost $

Answer 1

Answer: Weighted average floatation curve is 11.00%

True cost is $14,483,146.

Explanation:

Weighted average floatation cost is equal to weighted average of the floatation costs for debt and equity.

Let the equity be 1%

Given that debt to equity ratio is equal to 0.5%

Debt/Equity is 0.5

Debt/1= 0.5

Debt= 0.50 × 1.00 = 0.50

Assumed value:

For debt= 0.50

For equity = 1.00

Totals= 1.50

For weight (a):

Debt= 0.33

Equity= 0.67

Totals= 1.00

For costs(b)

Debt= 9%

Equity= 12%

Weighted cost (a) × (b)

Debt= 0.33 × 9= 2.97 appr= 3.00

Equity= 0.67 ×12= 8.04 appr= 8.00

Totals = 3. 00 + 8.00= 11.00%

B.

True cost is the defined as the difference between the market price of a product and the comprehensive cost of that product to society. The term is normally used to draw attention to missing or hidden or minute costs that are not found in the market price, even though it could theoretically apply to hidden benefits as well.

True cost is equal to total cost of new assembly line including floatation cost.

True cost × (1 - 11%) = $12,000,000

True cost × (1- 0.11)= $12,000,000

True cost × (0.89) = $12,000,000

True cost = $12,000,000/ 0.89

True cost= $13,483,146.