Question

BT Corporation has decided to build a new facility for its R&D department. The cost of the facility is estimated at $125 million. The firm plans to finance this project using its traditional debt-equity ratio of .65. The issue cost of equity is 6.1 percent and the issue cost of debt is 1.8 percent. What is the amount of the total flotation cost?

Answer 1

Answer:

$5.506 million

Explanation:

Data provided in the question:

Cost of the facility = $125 million

Debt-equity ratio = 0.65

cost of equity = 6.1 percent

cost of debt = 1.8 percent

Now,

Let the equity be 'E'

Thus,

$\frac{\textup{Debt}}{\textup{E}}$  = 0.65

or

Debt = 0.65E   .................(1)

Thus,

Debt + Equity = $125 million

0.65E + E = $125 million           [Debt = 0.65E from (1)]

1.65E = $125 million

or

E = $75.75 million

Thus,

Debt = 0.65E

or

= 0.65 × $75.75

= $49.24 million

Total flotation cost =  6.1% × $75.75 million + 1.8% × $49.24 million

=  (4.62 + 0.886) million

= $5.506 million