Hartley, Inc. needs to purchase equipment for its 2,000 drive-ins nationwide. The total cost of the equipment is $2 million. It is estimated that the after-tax cash inflows from the project will be $210,000 annually in perpetuity. Hartley has a market value debt-to-assets ratio of 40%. The firm's cost of equity is 13%, its pre-tax cost of debt is 8%, and the flotation costs of debt and equity are 2% and 8%, respectively. The tax rate is 34%. Assume the project is of similar risk to the firm's existing operations.

What is the weighted average flotation cost for Hartley?

Question

What is the weighted average flotation cost for Hartley?

Quizplus · Accepted Answer

First, calculate the weights of debt and equity based on the market value debt-to-assets ratio. With a 40% debt-to-assets ratio, the weights are 40% debt and 60% equity. Then, apply these weights to the flotation costs: (40% * 2%) + (60% * 8%) = 0.8% + 4.8% = 5.6%.