Question

Forwards, Inc., recently issued new securities to finance a new TV show. The project cost $35 million, and the company paid $2.2 million in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation cost of 3 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the company’s target debt-equity ratio?

Answer 1

floatation cost rate = floatation cost/total cost = 2.2/(35+2.2)=5.914%

let Wd=weight of debt; We=Weight of equity ; Fd=floatation cost of debt; Fe=floatation cost of equity ;

Weighted average floatation cost= Wd*Fd+(1-Wd)*Fe

5.914=Wd*3+(1-Wd)*7

5.914= -4Wd+7

Wd=(7-5.914)/4 =27.15%

We=1-Wd= 72.85%

------Therefore Debt /Equity ratio= Wd/We =27.15/72.85 = 37.27% =.3727