In determining the cost of capital, flotation costs should be: A) considered for debt but not for equity capital B) ignored for purposes of calculating the cost of capital C) deducted as a cash outflow at inception of the project D) subtracted from the price per share for calculationg the cost of new equity capital
C Cash outflow is the “CFA say we must do it this way and not consider the possibility of adjusting the discount rate” answer.
C is correct way 
of dealing with floatation costs
C as well
C correct.
B…it should be ignored in the calculation of the cost of capital and ADDED (not deducted) to the portion of the initial cash outflow that is associated with the flotation cost. For example, if the project costs 400k and is financed with 50% equity and the fee paid to the underwriter for the equity capital is 1%, then the initial cash outflow when determining the NPV is ((200,000*1.01)+200,000) = 202k. Flotation costs should be completely ignored when calculating the cost of capital, as they are one times costs and do not reoccur over the course of the project’s life.
mib20 Wrote: ------------------------------------------------------- > B…it should be ignored in the calculation of the > cost of capital and ADDED (not deducted) to the > portion of the initial cash outflow that is > associated with the flotation cost. For example, > if the project costs 400k and is financed with 50% > equity and the fee paid to the underwriter for the > equity capital is 1%, then the initial cash > outflow when determining the NPV is > ((200,000*1.01)+200,000) = 202k. Flotation costs > should be completely ignored when calculating the > cost of capital, as they are one times costs and > do not reoccur over the course of the project’s > life. As per book: correct answer is C.
which book/question#?
stalla exam practice book
read cfai or schweser on the correct way to account for this. the word deducted makes this answer wrong.
mib20 Wrote: ------------------------------------------------------- > read cfai or schweser on the correct way to > account for this. the word deducted makes this > answer wrong. Good. This is why you are the only one to answer B.
explain the logic behind “deducting” flotation costs then and i will give you credit
The floation cost is the cost of financing that you have to pay for issuing the new securities. It’s perfectly logical to think of this as an upfront cash outflow that needs to be deducted from your NPV calculation.
It is theoretically more correct to recognize the cash outflow for financing costs at the inception of the project. To increase the discount rate for the proportion of flotation costs included in the cost of equity ignores the differences in the timing and amount of cash flows. SInce flotation costs fenerally are relatiely low for debt and preferred stock, they may oftner be ignored in calculationg the cost of these capital components. By the way I also bet you are italian
just realized we are arguing the same point…i read the ? as deducting the cost from the initial cash outlay rather than from NPV
strangedays Wrote: ------------------------------------------------------- > It is theoretically more correct to recognize the > cash outflow for financing costs at the inception > of the project. > To increase the discount rate for the proportion > of flotation costs included in the cost of equity > ignores the differences in the timing and amount > of cash flows. SInce flotation costs fenerally are > relatiely low for debt and preferred stock, they > may oftner be ignored in calculationg the cost of > these capital components. > > By the way I also bet you are italian what is the final answer??? B or C
daj224 Wrote: ------------------------------------------------------- > strangedays Wrote: > -------------------------------------------------- > ----- > > It is theoretically more correct to recognize > the > > cash outflow for financing costs at the > inception > > of the project. > > To increase the discount rate for the > proportion > > of flotation costs included in the cost of > equity > > ignores the differences in the timing and > amount > > of cash flows. SInce flotation costs fenerally > are > > relatiely low for debt and preferred stock, > they > > may oftner be ignored in calculationg the cost > of > > these capital components. > > > > By the way I also bet you are italian > > > what is the final answer??? B or C C dude
I do believe MIB is right. Flotation cost should be ignored when calculating cost of capital. Think about it a minute considering what the question is ASKING and u will begin to make sense in what MIB said C) deducted as a cash outflow at inception of the project is considered when calculating the NPV of the project
regardless, any question on the exam wouldn’t be worded this poorly. as far as italian, couldn’t have been more off…second guess?
So MIB20 Where u right or wrong?