The Faraway Moving Company is involved in a major plant expansion that involves the expenditure...

Question:

The Faraway Moving Company is involved in a major plant expansion that involves the expenditure of $177 million in the coming year.

The firm plans on financing the expansion through the retention of $145 million in firm earnings and by borrowing the remaining $32 million.

In return for helping sell the $32 million in new debt, the firm's investment banker charges a fee of 300 basis points. (where one basis point is 0.01 percent) .

If Faraway decides to adjust for these flotation costs by adding them to the initial outlay, what will the initial outlay for the project be?

Flotation Costs and Capital Budgeting

There are two approaches for incorporating flotation costs in project evaluation: (1) adjust the weighted average cost of capital (WACC) to reflect the flotation costs or (2)Leave the WACC unchanged but adjust flotation costs in the initial outlay.

Answer and Explanation:

  • When a firm raises finance by issuing equity or debt, it almost invariably incurs flotation costs or issue costs. One of the approaches followed to...

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Cost of Capital: Flotation Cost, NPV & Internal Equity

from Corporate Finance: Help & Review

Chapter 3 / Lesson 18
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