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Question - Thinking about the definition of the term "flotation costs," should we expect the flotation costs for debt to be significantly lower than those for equity? Why or why not?
Answer - FLOTATION COSTS - Comparison with Debt and Equity
Flotation costs are significantly lower in case of debts and preferred equity and heavy for offering equity capital. It is the expenses incurred to offer securities which include underwriting fees, legal expenses, registration fees, etc. These costs are basically expected to be lower since these are the expenses which are incurred while in the process of raising extra capital and also when the company is to issue new securities. In the case where debt and equity are being raised in the organization, these costs are not involved in the estimation of cost of capital due to the fact that these costs are almost negligible and in most cases, less than 1%. Once the flotation costs are determined by the company, they are incorporated into the final price of the issued securities.
In the issuance of bonds generally flotation costs are lower, however in our example the costs are around 10% which is more than the average flotation costs for equity which is around 2% -8%. In the case of raising debts, Flotation costs are only 10% which requires the company to raise 1.11 million in place of 1 million. As the sale price agreed is $950, due to increased amount required the no. Of bonds to be issued are 1,169. If it had been equity instead of debts, the flotation costs would have been quite higher as underwriting fees forms a major component which is costly.
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