Kottinger's Kamp Supplies is considering an investment in new manufacturing equipment. The equipment costs $220,000 and will provide annual after-tax inflows of $50,000 at the end of each of the next seven years. The firm's market value debt/equity ratio is 25%, its cost of equity is 14%, and its pre-tax cost of debt is 7%. The flotation costs of debt and equity are 3% and 9%, respectively. The firm's combined marginal federal and provincial tax rate is 40%. Assume the project is of approximately the same risk as the firm's existing operations.

What is the weighted average flotation cost for Kottinger's?

Question

What is the weighted average flotation cost for Kottinger's?

Quizplus · Accepted Answer

The weighted average flotation cost is calculated by taking into account the proportions of debt and equity in the firm's financing and the respective flotation costs for each. The firm's market value debt to equity ratio is 25%, which means that for every $100 of equity, there is $25 of debt. This translates to weights of 20% for debt (25/(25+100)) and 80% for equity (100/(25+100)). The weighted average flotation cost is then calculated as (20% * 3%) + (80% * 9%) = 0.6% + 7.2% = 7.8%.

Kottinger's Kamp Supplies Is Considering an Investment in New Manufacturing