Question

Caughlin Company needs to raise $75 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 75 percent common stock, 5 percent preferred stock, and 20 percent debt. Flotation costs for issuing new common stock are 11 percent, for new preferred stock, 8 percent, and for new debt, 3 percent.
What is the true initial cost figure the company should use when evaluating its project? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.)
Initial cost $

Answer 1

Answer: $82,644,628

Explanation:

The true initial cost figure that the company should use when evaluating its project will be calculated as:

First we calculate the weighted average flotation which will be:

= (0.75 × 0.11) + (0.05 × 0.08) + (0.20 × 0.03)

= 9.25%

Therefore, the amount raised will be:

= 75 million / (1 - 9.25%)

= 75 million / (1 - 0.0925)

= $82,644,628

Therefore, the true initial cost is $82,644,628.