Question

The Upper Tier has a current debt-equity ratio of .52 and a target debt-equity ratio of .45. The cost of floating equity is 9.5 percent and the flotation cost of debt is 6.6 percent. What should the firm use as their weighted average flotation cost?

Answer 1

Answer: 8.60%

Explanation:

Given the following :

Current debt-equity ratio = 0.52

Target debt-equity ratio = 0.45

Cost of floating equity = 9.5%

Floatation cost of debt = 6.6%

The Weighted average cost is calculated by finding the Weighted average cost of both debt and equity.

1 + 0.45 = 1.45

Weight of debt= 0.45/ 1.45 =0.31034

Weight * cost of debt

0.31034 × 6.6% = 2.0482758

Weight of equity = 1/1.45 = 0.6896551

Weight * cost of equity

0.6896551 × 9.5% = 6.5517241

Sum of both

(6.55 + 2.05) % = 8.60%