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Caughlin Company needs to raise $40 million to start a new project and will raise the money by...

Question:

Caughlin Company needs to raise $40 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 50 percent common stock, 15 percent preferred stock, and 35 percent debt. Flotation costs for issuing new common stock are 8 percent, for new preferred stock, 5 percent, and for new debt, 2 percent.

What is the true initial cost figure the company should use when evaluating its project?

Initial Investment having flotation costs.

When there is flotation costs to issue debt or stock we can apply to methods to consider it. First method is to consider the flotation costs in calculating required rate of return which will effect in increasing the rate.

Second method is to consider the flotation costs as addition to the initial investment.

Answer and Explanation:

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In the question above as per the context we have to calculate initial investment as per the second method.

In the question we require $40 million net...

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Capital Structure & the Cost of Capital

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Chapter 15 / Lesson 1
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In this lesson, we'll define capital and a firm's capital structure. We'll also discuss the costs associated with each component in the capital structure and learn about the concept of risk and return.


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