Question

Thinking about the definition of the term "flotation costs," should we expect the flotation costs for debt to be significantly lower than those for equity? Why or why not? Please support your answer using supporting information from the chapters in this unit and the course.

Answer 1

Flotation cost are generally considered with equity financing and it is mostly related to initial public offer or rights issue because these equity financing methods are generally considered with appointment of underwriter and they are also having a risk of getting their share listed at a price which is lower than the the intrinsic value because they are based upon the valuation of the investment bankers.

So it can be concluded that flotation cost of equity is significantly very higher than that of debt capital because that capitals are not having any kind of third party intermediaries who will decide upon the cost of these issuance and cost of the issuance of debt capital is generally lower whereas cost of issuance of equity shares are generally higher because of involvement of underwriters who would be paid underwriting commission and there would also be a difference on the part of the price of those initial public offer which is also known as underpricing of the initial public offer, so it can be concluded that floatation cost of equity will be more higher than that of debt capital.