Question

If a firm has a cost of equity of 15 percent, and the firm is 100 percent equity financed. The firm is contemplating a $150 million expansion of its existing operations, funded by selling new stock. Flotation costs will run 10 percent of the amount issued. When flotation costs are considered, what is the cost of expansion?
a. $135 million
b. $150 million
c. $166.67 million
d. $175 million
e. $185.67 million

Answer 1

Answer:

c. $166.67 million

Explanation:

cost of expansion = new equity issued / (1 - flotation costs)

cost of expansion = $150 million / (1 - 10%) = $150 million / 90% = $166.67 million

Flotation costs increase the cost of equity, since they are an expense that decreases the net amount of money received by a corporation when it issued new stocks or new bonds.