Question
A firm has a target debt-equity ratio of .5, but it plans to finance a new project with all debt. What debt-equity ratio should be used when calculating the project's flotation costs?
Multiple choice question.
1
.25
.33
.5
Multiple choice question.
1
.25
.33
.5
Answers
GPT-4o mini
In finance, the flotation costs typically reflect the costs associated with issuing new securities to finance a project. When considering the appropriate debt-equity ratio for calculating these costs, one should generally use the firm's target debt-equity ratio, especially if that ratio is a reflection of the firm's long-term capital structure.
Given the firm has a target debt-equity ratio of 0.5, this means that for every $1 of equity, the firm aims to have $0.5 of debt (or equivalently, for every $0.5 of debt, the firm aims to have $1 of equity). Hence, your target debt-equity ratio calculation would be:
- For a debt-equity ratio of 0.5,
\[
D = 0.5E
\]
This ratio translates into debt (D) being half of equity (E).
Thus, when calculating project flotation costs, the appropriate debt-equity ratio to use is 0.5, as it reflects the firm's target financing structure, despite the decision to finance the new project with all debt in the short term.
**Correct Answer: 0.5**
Given the firm has a target debt-equity ratio of 0.5, this means that for every $1 of equity, the firm aims to have $0.5 of debt (or equivalently, for every $0.5 of debt, the firm aims to have $1 of equity). Hence, your target debt-equity ratio calculation would be:
- For a debt-equity ratio of 0.5,
\[
D = 0.5E
\]
This ratio translates into debt (D) being half of equity (E).
Thus, when calculating project flotation costs, the appropriate debt-equity ratio to use is 0.5, as it reflects the firm's target financing structure, despite the decision to finance the new project with all debt in the short term.
**Correct Answer: 0.5**