Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.40. The flotation cost for equity is 3 percent, the flotation cost for debt is 2 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the weighted average flotation cost for the firm?

Question

Quizplus · Accepted Answer

The weighted average flotation cost is calculated by taking the weighted average of the flotation costs for equity and debt, based on the firm's debt-to-assets (D/A) ratio and equity-to-assets (E/A) ratio. Given a D/A ratio of 0.40, the E/A ratio is 1 - 0.40 = 0.60. The flotation cost for equity is 3 percent and for debt is 2 percent. Therefore, the weighted average flotation cost is (0.60 * 3%) + (0.40 * 2%) = 1.8% + 0.8% = 2.6%.

Your Company Is Considering a Project That Will Cost $100