Question

Downtown Stores can issue equity at a flotation cost of 8.76 percent and debt at 5.93 percent. The firm currently has a debt-equity ratio of .37 but prefers a ratio of .35. What should this firm use as their weighted average flotation cost

Answer 1

Answer:

8.03%

Explanation:

The computation is shown below:

We know that

Total capital = Debt + Equity

= 0.35 + 1

= 1.35

Now  

Weight of debt(Wd) = Value of debt ÷ Total capital

= 0.35 ÷ 1.35

Weight of equity(We) = 1 ÷ 1.35

Now Weighted average flotation cost is:

= Flotation cost of equity × weight of equity + Flotation cost of debt × Weight of debt

= (8.76% × 1 ÷ 1.35) + (5.93% × 0.35 ÷ 1.35)

= 8.03%