Question

Fiat Inc. has a target debt-equity ratio of 0.52. The cost of floating equity is 4.75 percent and the flotation cost of debt is 3.3 percent. The firm’s tax rate is 24 percent. What should the firm use as their weighted average flotation cost?

A. 4.25%

B. 4.05%

C. 4.00%

D. 3.50%

Answer 1

Solution:
	Answer is A. 4.25%
Working notes:
	weighted average flotation cost
	Debt equity ratio = 0.52
	Debt ratio = 0.52/(0.52+1) = 0.52/1.52
	Equity ratio = 1/(0.52+1) = 1/1.52
	Kd= flotation cost of debt=3.3%
	Ke= cost of floating equity = 4.75%
	weighted average flotation cost
	WACC = Kd x Debt ratio + Ke x Equity ratio
	WACC= 3.3% x (0.52/1.52) + 4.75% x (1/(1+0.52))
	WACC =0.042539474
	WACC = 4.2539%
	WACC = 4.25%
	weighted average flotation cost =4.25%
Notes:	Floatation cost is cost for raising capital , so cost of capital is considered net of floatation cost , it tax benefit is not happen as it is capital cost , not operating cost
Please feel free to ask if anything about above solution in comment section of the question.