Your company is considering a project that will cost $175. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10% and the firm's D/A ratio is .62. The flotation cost for equity is 5%, the flotation cost for debt is 3%, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the firm's flotation-adjusted cash flow in year 0?

Question

Quizplus · Accepted Answer

To calculate the flotation-adjusted cash flow in year 0, we need to adjust the initial investment for flotation costs. The firm's D/A ratio is 0.62, meaning 62% of the financing is debt and 38% is equity. The flotation cost for debt is 3%, and for equity, it is 5%. The adjusted initial investment is calculated as follows: Debt portion = 0.62 * $175 = $108.50  Equity portion = 0.38 * $175 = $66.50  Flotation cost for debt = 3% of $108.50 = $3.255  Flotation cost for equity = 5% of $66.50 = $3.325  Total flotation cost = $3.255 + $3.325 = $6.58  Flotation-adjusted initial investment = $175 + $6.58 = $181.58  Therefore, the flotation-adjusted cash flow in year 0 is -$181.84.

Your Company Is Considering a Project That Will Cost $175