Nippon Post Corporation (NPC), a Japanese software development firm, has a capital structure that is comprised of 60% common equity and 40% debt. In order to finance several capital projects, NPC will raise USD1.6 million by issuing common equity and debt in proportion to its current capital structure. The debt will be issued at par with a 9% coupon and flotation costs on the equity issue will be 3.5%. NPC’s common stock is currently selling for USD21.40 per share, and its last dividend was USD1.80 and is expected to grow at 7% forever. The company’s tax rate is 40%. NPC’s WACC based on the cost of new capital is closest to: A) 9.6%. B) 13.1%. C) 11.8%. Your answer: B was incorrect. The correct answer was C) 11.8%. kd = 0.09(1 – 0.4) = 0.054 = 5.4% kce = [(1.80 × 1.07) / 21.40] + 0.07 = 0.16 = 16.0% WACC = 0.6(16.0%) + 0.4(5.4%) = 11.76% Flotation costs, treated correctly, have no effect on the cost of equity component of the WACC. --------------- I’m not sure why floatation costs would have no effect on the cost of equity component of WACC? I was under the impression floatation costs increased the cost of equity component of WACC? Thank you for any assistance!
I believe the more accepted treatment of flotation costs is mot to increase the cost of equity but rather to include the actual monetary amount in the initial cost of the project when calculating NPV. Flotation costs are a one time event, incurred only when a company decides to raise capital. Adjusting the cost of capital would be misleading, it ignores the greater cash outflow investment and thus results in a higher NPV.