Flotation costs for a levered firm should be:
A) ignored when analyzing a project because they are a sunk cost.
B) spread over the life of a project thereby reducing the cash flows for each year of the project.
C) considered only when two projects are mutually exclusive.
D) weighted and included in the initial cash flow.
E) totally ignored when internal equity funding is utilized.

Question

Quizplus · Accepted Answer

Flotation costs represent the fees incurred by a firm when issuing new securities. These costs should be considered when analyzing a project because they decrease the initial cash inflow of the project. The most accurate way to include flotation costs in the analysis is to weight them based on the proportion of equity and debt financing used by the firm, and then include the weighted average in the initial cash flow. It is important to note that flotation costs are not a sunk cost.

Flotation Costs for a Levered Firm Should Be