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. Issue costs and WACC The ASSEN PLC. is currently at its target debt...

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Finance

. Issue costs and WACC

The ASSEN PLC. is currently at its target debt ratio of 30%. It is contemplating a $5 million expansion of its existing business. This expansion is expected to produce a cash inflow of $635.000 a year in perpetuity. The company is uncertain whether to undertake this expansion and how to finance it. The two options are a $5 million issue of common stock or a $5 million issue of 20-year debt. The flotation costs of a stock issue would be around 7% of the amount raised, and the flotation costs of a debt issue would be around 2%. ASSEN`s financial manager, estimates that the required return on the companys equity is 15%, but argues that the flotation costs increase the cost of new equity to 22%. On this basis, the project does not appear viable. On the other hand, she points out that the company can raise new debt on a 8% yield, which would make the cost of new debt 10%. She therefore recommends that the company should go ahead with the project and finance it with an issue of long-term debt, especially also considering the high corporate tax rate of 40%. Is the financial manager right? How would you evaluate the project?

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