Flotation Costs and WACC

While raising new capital, a company incurs cost, which is paid as a fee to the investment bankers.

This fee is referred to as the flotation cost. The amount of fee depends on the size and type of offering.

Flotation cost is generally less for debt and preferred issues, and most analysts ignore it while calculating the cost of capital. However, the flotation cost can be substantial for issue of common stock, and can go as high as 6-8%.

In the investment industry, there are different views about whether flotation costs should be incorporated in the calculation of cost of capital or not.

Including Flotation Cost in Calculating Cost of Capital

If we decide to include the flotation costs in our calculation, then the formula for the cost of equity will be modified as follows:

$r_{e}=\frac{D_{1}}{P_{0}(1-f)}+g$