Question

The BIM Corporation has decided to build a new facility for its R&D department. The cost of the facility is estimated to be $125 million. BIM wishes to finance this project using its traditional debt-equity ratio of 1.5. The issue cost of equity is 6% and the issue cost of debt is 1%. What is the total flotation cost?

Answer 1

Answer:

$3,750.000

Explanation:

Debt / Equity = 1.5

Let represent equity = x

Debt= 1.5x

Hence, x + 1.5x = $125,000,000

2.5x = $125,000,000

x = $125,000,000/2.5

x (Equity) = $50,000,000

Debt = $125,000,000 - $50,000,000

Debt = $75,000,000

issue cost = Debt*Cost of debt + Equity*Cost of Equity

issue cost = $75,000,000*1% + $50,000,000*6%

issue cost = $750,000 + $3,000,000

issue cost = $3,750.000

Hence, total flotation cost is $3,750.000