Question

Being Human, Inc., recently issued new securities to finance a new TV show. The project cost $35 million, and the company paid $2.2 million in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation cost of 3 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the company's target debt-equity ratio? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., .1616.) Debt-equity ratio

Answer 1

Total costs = Project's cost + Flotation cost = $35,000,000 + $2,200,000 = $37,200,000

Amount raised(1 – fT) = Amount needed after flotation costs

$37,200,000(1 – fT) = $35,000,000

1 - fT = $35,000,000 / $37,200,000

fT = 1 - 0.9409 = 0.0591, or 5.91%

wD + wE = 1

wD = 1 - wE

WAFC = [wD * Debt's fT] + [wE * Equity's fT]

0.0591 = [wD * 0.03] + [(1 - wD) * 0.07]

0.0591 = [wD * 0.03] + 0.07 - [wD * 0.07]

0.0591 - 0.07 = -[wD * 0.04]

-0.0109 = -[wD * 0.04]

wD = -0.0109 / -0.04 = 0.2715

wE = 1 - wD = 1 - 0.2715 = 0.7285

D/E = wD / wE = 0.2715 / 0.7285 = 0.3727