Harmon, Inc. has a debt-equity ratio of.80. The firm is analyzing a new project which requires an initial cash outlay of $300,000 for new equipment. The flotation cost for new equity is 9 % and for debt 4.5 %. What is the initial cost of the project including the flotation costs?

Question

Quizplus · Accepted Answer

The initial cost of the project including flotation costs is calculated by considering the weighted average flotation cost based on the debt-equity ratio. The equity portion is 1/(1+0.8) = 0.5556 and the debt portion is 0.8/(1+0.8) = 0.4444. The weighted average flotation cost is (0.5556 * 9%) + (0.4444 * 4.5%) = 7.05%. The total initial cost is $300,000 * (1 + 0.0705) = $322,581.