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Unformatted text preview: Answer: The company is raising money in order to make an investment. The money has a cost, and this cost is based primarily on the investors required rate of return, considering risk and alternative investment opportunities. So, the new investment must provide a return at least equal to the investors opportunity cost . If the company raises capital by selling stock, the company doesnt get all of the money that investors put up. For example, if investors put up $100,000, and if they expect a 15 percent return on that $100,000, then $15,000 of profits must be generated. But if flotation costs are 20 percent ($20,000), then the company will receive only $80,000 of the $100,000 investors put up. That $80,000 must then produce a $15,000 profit, or a 15/80 = 18.75% rate of return versus a 15 percent return on equity raised as retained earnings....
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.
- Spring '08