Southwest Tours needs $134,000 for a new project.The firm has a target capital structure of 25 percent debt and 75 percent equity.The flotation cost of debt is 5.4 percent compared to 8.6 percent for equity.What amount does the firm need to raise if it generates sufficient internal equity to cover the equity need?

Question

Quizplus · Accepted Answer

First, we need to find the amount of debt and equity needed to fulfill the target capital structure:

Debt = 0.25 x $134,000 = $33,500
Equity = 0.75 x $134,000 = $100,500

Next, we need to account for the flotation costs of debt and equity:

Flotation cost of debt = 5.4%
Flotation cost of equity = 8.6%

To find the adjusted amount of debt needed, we use the following formula:

Adjusted Debt = Debt / (1 - Flotation Cost of Debt)
Adjusted Debt = $33,500 / (1 - 0.054)
Adjusted Debt = $35,500.53

To find the adjusted amount of equity needed, we use the following formula:

Adjusted Equity = Equity / (1 - Flotation Cost of Equity)
Adjusted Equity = $100,500 / (1 - 0.086)
Adjusted Equity = $110,624.36

Since the firm can generate sufficient internal equity to cover the equity need, the total amount the firm needs to raise is the adjusted amount of debt:

Total Amount = Adjusted Debt = $35,500.53

Therefore, the best choice is C.

Southwest Tours Needs $134,000 for a New Project