Floatation Costs

Floatation Costs

Floatation costs refer to expenses incurred by a company when issuing new shares. According to Li & Wang (2021), floatation costs are one-time expenses that require adjustments using future cash flows to avoid overstating the cost of capital for a long time, especially in the case of equity. While considering equity capital, flotation costs cost new equity more than the existing equity. Regarding debt capital, floatation costs are incurred as expenses of issuing new securities. Overall, floatation costs occur in the form of registration fees, legal fees, underwriting fees, and audit fees. There are floatation costs that are specifically associated with equity capital and those that are specifically incurred for acquiring debt (Martellini et al., 2018). There can be a difference in the total floatation costs incurred while obtaining equity capital and debt capital. However, the question of which type of funding option results in more floatation costs is subject to debate.

In my opinion, floatation costs for debt capital are expected to be significantly lower than those of equity capital. Notably, this is so because more legal formalities are met when raising equity financing than debt financing (Gupta et al., 2018). However, it is important to note that floatation costs vary based on factors such as company relationship with lenders, issue type, issue size, and company size. The floatation costs of a less-known company issuing equity or securities will be higher than those of a well-established, popular company (Cornett et al., 2016). Thus, my opinion regarding which floatation costs are higher between the issue of equity and debt is based on the same company. Essentially, this means that for a given company, floatation costs for issuing debt will be expected to be lower as compared to the same company issuing equity due to the formalities required for each option.

References

Cornett, M. M., Adair, Jr, T. A., & Nosfinger, J. (2016). M-Finance (3rd ed.). New York, NY: McGraw Hill/ Irwin.

Gupta, K., Krishnamurti, C., & Tourani-Rad, A. (2018). Financial development, corporate governance, and cost of equity capital. Journal of Contemporary Accounting & Economics, 14(1), 65-82.

Li, Z., & Wang, P. (2021). Flotation costs of seasoned equity offerings: Does corporate social responsibility matter?. European Financial Management. https://doi.org/10.1111/eufm.12327

Martellini, L., Milhau, V., & Tarelli, A. (2018). Capital structure decisions and the optimal design of corporate market debt programs. Journal of Corporate Finance, 49, 141-167.

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Unit 7 Discussion: Flotation CostsUnit 7 Discussion: Flotation Costs

Floatation Costs

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? Please support your answer using supporting information from the chapters in this unit and the course