12 Southern Alliance Company needs to raise 55 million to st

12. Southern Alliance Company needs to raise $55 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 55 percent common stock, 15 percent preferred stock, and 30 percent debt. Flotation costs for issuing new common stock are 7 percent, for new preferred stock, 4 percent, and for new debt, 2 percent. What is the true initial cost figure the company should use when evaluating its project? (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.) Initial cost

Solution

Solution: Initial cost $57,925,224 Working Notes: True initial cost = Amount to be raised / (1- weighted average floatation cost) Amount to be raised = $55,000,000 weighted average floatation cost = Sum of ( Flotation rate cost of capital x weight in capital structure) =7% x 0.55 + 4% x 0.15 + 2% x 0.30 =3.85% + 0.60% + 0.60% =5.05% =0.0505 True initial cost = Amount to be raised / (1- weighted average floatation cost) =$55,000,000/(1- 0.0505) =$55,000,000/0.9495 =$57,925,223.802 =$57,925,224 Please feel free to ask if anything about above solution in comment section of the question.