Plat Tools Corporation (PTC) has a target capital structure of 40% debt and 60%

Question

Plat Tools Corporation (PTC) has a target capital structure of 40% debt and 60% equity. The marginal tax rate is 40%. The cost of debt is 8%, The company?s shares trade at £20 per share. Next year?s expected dividend is £2.00 per share and its long-term dividend growth rate is 5%. If new equity is issued, floatation costs amount to 6% of the issue price or £1.20 per share. PTC has identified a new project in which to invest. The project will cost £35,000,000 and will generate after-tax operating cash flows £6,100,000 per year for the next ten years. There will be no non-operating cash flow at the project, the firm will borrow 40% of its cost at the debt rate and issue new stock for the remaining 60% of the cost. Calculate the net present value of the project assuming the floatation costs are a cash flow of the project

Explanation / Answer

First find the floatation costs. The firm needs to raise equity of 60% x £35,000,000, or £21,000,000. To raise this amount net of floatation costs, the firm has issue £22,340,426 (£21,000,000 / 0.94) in new shares. After paying 6% or £1,340,426, to the net proceeds are the £21,000,000. Thus, the cost of the issuance is £1,340,426 (£22,340,426 - £21,000,000). Next the WACC without the issue cost if found: WACC = wDrD(1-t) + wPrP + wCErCE The NPV is found with floatation cost being treated as an initial cash outflow; thus, the initial outlay is £1,340,426 + £35,000,000 = £36,340,426: 10 NPV = -£36,340,426 + S£6,100,000/ (1.1092)t = -£295,282 t=1 Thus, the NPV is negative and the project should not be undertaken. This approach more accurately reflects the full cost of the new financing. The other method misses a portion of this cost

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