Page 37 - FINAL CFA I SLIDES JUNE 2019 DAY 10
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Session Unit 10:
36. Cost of Capital
Correct Treatment of Flotation Costs, p.55
Example: Correctly accounting for flotation costs, p.55: Omni Corporation is considering a project that requires a
$400,000 cash outlay and is expected to produce cash flows of $150,000 per year for the next four years. Omni’s
tax rate is 35%, and the before-tax cost of debt is 6.5%. The current share price for Omni’s stock is $36 per share,
and the expected dividend next year is $2 per share. Omni’s expected growth rate is 5%. Assume that Omni
finances the project with 50% debt and 50% equity capital and that flotation costs for equity are 4.5%. The
appropriate discount rate for the project is the WACC.
Calculate the NPV of the project using the correct treatment of flotation costs and discuss how the result of this
method differs from the result obtained from the incorrect treatment of flotation costs.
tanties
• What accounts for the NPV difference? • Correct and incorrect treatment of flotation costs!
• Note that flotation costs may be tax-deductible e.g. Omni’s after-tax flotation cost of $9,000(1 – 0.35) = $5,850;
Project NPV then = $97,790.
