The MFC Corporation has decided to build a new facility. The cost of the facility is estimated to be $9.7 million. MFC wishes to finance this project using its traditional debt-to- equity ratio of 1.5. The issue cost of equity is 6% and the issue cost of debt is 1%. What is the total floatation cost of raising funds?
A) $300,000
B) $100,000
C) $600,000
D) None of the above

Question

Quizplus · Accepted Answer

To maintain a debt-to-equity ratio of 1.5, for every $1 of equity, $1.5 of debt is needed. Let equity be x, then debt is 1.5x. So, x + 1.5x = $9.7 million, solving gives x = $3.88 million (equity) and 1.5x = $5.82 million (debt). The floatation cost is 6% of equity + 1% of debt = 0.06 * $3.88 million + 0.01 * $5.82 million = $0.2328 million + $0.0582 million = $0.291 million, approximately $300,000.

The MFC Corporation Has Decided to Build a New Facility