Question

Being Human, Inc., recently issued new securities to finance a new TV show. The project cost $13.5 million, and the company paid $675,000 in flotation costs. In addition, the equity issued had a flotation cost of 6.5 percent of the amount raised, whereas the debt issued had a flotation cost of 2.5 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:

0.7684

Explanation:

The computation of debt-equity ratio is shown below:-

Let the amount of equity issued = x

Amount of debt = Project cost + Flotation cost - Amount of equity issued

$13,500,000 + $675,000 - x

Net amount received from equity = Amount of equity issued × (1 - Equity issued percentage)

= x × (1 - 0.065)

= Flotation cost of equity = Amount of equity issued × Equity issued percentage)

= x × 0.065

Net amount received from debt = (Project cost + Flotation cost - Amount of equity issued) × (1 - Debt issued percentage)

= ($13,500,000 + $675,000 - x) × (1 - 0.025)

Conditionally

x × 0.065 + ($13,500,000 + $675,000 - x) × 0.025 = $675,000

0.04 × x + $354,375  = $675,000

0.04 × x = $320,625

x = $8,015,625

Debt = $13,500,000 + $675,000 - $8,015,625

= $6,159,375

Target debt-equity ratio = Debt ÷ Equity

= $6,159,375 ÷ $8,015,625

= 0.7684