Question

Being Human, Inc., recently issued new securities to finance a new TV show. The project cost $14.1 million, and the company paid $735,000 in flotation costs. In addition, the equity issued had a flotation cost of 7.1 percent of the amount raised, whereas the debt issued had a flotation cost of 3.1 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the company’s target debt-equity ratio? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., .1616.)

Answer 1

Answer:

The company’s target debt-equity ratio is 1.16 : 1

Explanation:

Percentage flotation costs = 1 - (14100000/14100000 + 735000)

                                             = 1 - (14100000/14835000)

                                             = 4.95%

We know that:

(1 + Debt/Equity)*4.95%  = 0.071 + 0.031*(Debt/Equity)(Percentage flotation cost equation)

0.0495 + 0.0495*(Debt/Equity) = 0.071 + 0.031*(Debt / Equity)

0.049545*(Debt/Equity) - 0.031*(Debt/Equity) = 0.071 - 0.0495

0.018545*(Debt/Equity) = 0.021455

Debt/Equity = 0.021455/0.018545

Debt / Equity = 1.16 : 1

Therefore, The company’s target debt-equity ratio is 1.16 : 1