Flotation Costs And The Weighted Average Cost Of Capital

So far, we have not included issue, or flotation, costs in our discussion of the weighted average cost of capital. If a company accepts a new project, it may be required to issue, or float, new bonds and stocks. This means that the firm will incur some costs, which we call flotation costs. The nature and magnitude of flotation costs are discussed in some detail in Chapter 16.

Sometimes it is suggested that the firm's WACC should be adjusted upwards to reflect flotation costs. This is really not the best approach, because, once again, the required return on an investment depends on the risk of the investment, not the source of the funds. This is not to say that flotation costs should be ignored. Because these costs arise as a consequence of the decision to undertake a project, they are relevant cash flows. We therefore briefly discuss how to include them in a project analysis.

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