Suppose your company needs 13 million to build a new assembl

Suppose your company needs $13 million to build a new assembly line. Your target debt?equity ratio is .55. The flotation cost for new equity is 6 percent, but the flotation cost for debt is only 3 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.

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.)

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, e.g. 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.)

Solution

Debt Equity Ratio = 0.55
Debt to total Value = 0.55/1.55
Equity to total Value = 1/1.55
a)Weighted Average flotation cost = Flotation cost of debt * Debt/Total value + Flotation cost of Equity * Equity/Total Value = 3% * 0.55/1.55 + 6% * 1/1.55 = 4.94%

b) True cost of building assembly line = 13,000,000 + Wighted average flotation cost * 13,000,000 = 13,641,612.90

Best of Luck. God Bles