Manning Co. is considering a one-year project that requires an initial investment of $500,000; however, in raising this capital, Manning will incur an additional flotation cost of 2.0%. At the end of the year, the project is expected to produce a cash inflow of $550,000.
Determine the rate of return that Manning expects to earn on the project after flotation costs are taken into account.
Flotation costs are transactions costs associated with issuing securities in the capital market. One important component of flotation costs are underwriting fees charged by investment banks.
Answer and Explanation:
We first compute the total cost, including the flotation costs of 2%. Given initial investment of 500,000, the total cost is:
- 500,000 + 500,000 * 2% = 510,000.
The cash inflow from the project is 550,000 in one year, so the rate of return is
- rate of return = (550,000 -510,000) / 510,000
- rate of return = 7.84%
Become a member and unlock all Study Answers
Try it risk-free for 30 daysTry it risk-free
Ask a question
Our experts can answer your tough homework and study questions.Ask a question Ask a question
Learn more about this topic:
from Corporate Finance: Help & ReviewChapter 3 / Lesson 18