Question

Your company needs $ 15 million to build a new assembly line. Your target debt-to-equity ratio is 0.6. The cost of issuing new equity is 8%, while the cost of issuing debt is 5%. What is the real cost of the new assembly line if you factor in issuance costs?

Answer 1

Debt to equity = 0.6 = 6/10 = 3/5

Debt weight = 3/8

Equity weight = 5/8

Weighted average of flotation cost= weight of debt × flotation cost rate from debt + weight of equity × flotation cost rate from equity

=( 3/8 )* 5% + (5/8) × 8%

=weighted average of flotation cost = 6.875%

Real cost of new assembly line if you factor in issuance cost = 15,000,000 / (1- 0.06875)

= 16,107,382.550336

Real cost of new assembly line if you factor in issuance cost = $ 16,107,382.550336