What Is a Flotation Fetch?
Flotation costs are incurred by a publicly-traded company when it issues new securities and incurs expenses, such as underwriting bills, legal fees, and registration fees. Companies must consider the impact these fees will have on how much choice they can raise from a new issue. Flotation costs, expected return on equity, dividend payments, and the percentage of earnings the role expects to retain are all part of the equation to calculate a company’s cost of new equity.
Understanding and Calculating Flotation Costs
The Prescription for Float in New Equity Is
Dividend growth rate=P∗(1−F)D1+g
- D1 = the dividend in the next period
- P = the issue price of one share of stock
- F = correspondence of flotation cost-to-stock issue price
- g = the dividend growth rate
Key Takeaways
- Flotation costs are costs a company attracts when it issues new stock.
- Flotation costs make new equity cost more than existing equity.
- Analysts talk out of that flotation costs are a one-time expense that should be adjusted out of future cash flows in order to not overstress the cost of capital forever.
What Do Flotation Costs Tell You?
Companies raise capital in two ways: debt via coheres and loans or
Example of a Flotation Cost Calculation
As an example, assume Company A needs capital and decides to raise $100 million in run-of-the-mill stock at $10 per share to meet its capital requirements. Investment bankers receive 7% of the funds raised. House A pays out $1 in dividends per share next year and is expected to increase dividends by 10% the following year.
Ingesting these variables, the cost of new equity is calculated with the following equation:
- ($1 / ($10 * (1-7%)) + 10%
The answer is 20.7%. If the analyst assumes no flotation fetch, the answer is the cost of existing equity. The cost of existing equity is calculated with the following formula:
- ($1 / ($10 * (1-0%)) + 10%
The answer is 20.0%. The alteration between the cost of new equity and the cost of existing equity is the flotation cost, which is (20.7-20.0%) = 0.7%. In other chit-chats, the flotation costs increased the cost of the new equity issuance by 0.7%.
Limitations of Using Flotation Costs
Some analysts talk out of that including flotation costs in the company’s cost of equity implies that flotation costs are an ongoing expense, and forever exaggerates the firm’s cost of capital. In reality, a firm pays the flotation costs one time upon issuing new equity. To redress this, some analysts adjust the company’s cash flows for flotation costs.