The weighted average cost of capital is 7.2 percent calculated as 0.40(3 percent) + 0.60(10 percent). Ignoring flotation costs for the moment, the net present value (NPV) of this project is

If the flotation costs are, say, 5 percent of the new equity capital, the flotation costs are €1,800. The net present value considering flotation costs is

If, instead of considering the flotation costs as part of the cash flows, we adjust the cost of equity, the cost of capital is 7.3578 percent and the NPV is

As you can see, we arrive at different assessments of value using these two methods.

42 This argument is made by John R. Ezzell and R. Burr Porter ["Flotation Costs and the Weighted Average Cost of Capital," Journal of Financial and Quantitative Analysis, Vol. 11, No. 3 (September 1976), pp. 403-413]. They argue that the correct treatment is to deduct flotation costs as part of the valuation as one of the initial-period cash flows.

So, if it is preferred to deduct the flotation costs as part of the net present value calculation, why do we see the adjustment in the cost of capital so often in textbooks? The first reason is that it is often difficult to identify particular financing associated with a project. Using the adjustment for the flotation costs in the cost of capital may be useful if specific project financing cannot be identified. Second, by adjusting the cost of capital for the flotation costs, it is easier to demonstrate how costs of financing a company change as a company exhausts internally generated equity (i.e., retained earnings) and switches to externally generated equity (i.e., a new stock issue).

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Attracting Wealth Through The Law Of Attraction

Attracting Wealth Through The Law Of Attraction

Wealthy people have this so called millionaires personal mindset, a way of thinking that separates the achievers and successful individuals from the rest of the population. Your subconscious is much powerful than the conscious mind. This can either help you fulfill your dreams or hold you from success that you want in your life.

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