Flotation Cost

Flotation Cost

What is a flotation cost?

Flotation costs are the fees a company pays when issuing new securities (typically equity). They include underwriting fees, legal and registration costs, accounting and audit fees, and stock-exchange listing charges. Flotation costs are expressed as a percentage of the issue price and reduce the net capital the company raises from an offering.

Why it matters

• Flotation costs increase the effective cost of new equity compared with existing equity.
• Companies factor flotation costs into decisions about raising funds from equity versus debt (often using the weighted average cost of capital, WACC).
• Because flotation costs are typically one-time expenses, some analysts adjust project cash flows for them instead of permanently increasing the cost of capital.

Formula (cost of new equity)

Cost of new equity (re) can be calculated with the dividend-growth model adjusted for flotation costs:
re = D1 / [P (1 − F)] + g

Where:
* D1 = expected dividend next period
* P = issue price per share
* F = flotation cost as a fraction of the issue price
* g = expected dividend growth rate

Example

Assume:
* Issue price P = $10 per share
* Expected next-period dividend D1 = $1
* Expected growth g = 10% (0.10)
* Flotation fee F = 7% (0.07)

Cost of new equity:
re = 1 / [10 × (1 − 0.07)] + 0.10
re = 1 / 9.3 + 0.10 ≈ 0.1075 + 0.10 = 0.2075 → 20.75%

Cost of existing equity (no flotation cost):
rs = 1 / 10 + 0.10 = 0.10 + 0.10 = 20.0%

Flotation cost impact = re − rs ≈ 0.75 percentage points (about 0.7% in the example).

Limitations and practical treatment

• Treating flotation costs as part of the ongoing cost of capital can overstate WACC, since they are usually one-time expenses.
• Common approaches:
• Add flotation costs directly to initial project costs or reduce the raised capital by the flotation percentage.
• Use the adjusted cost of new equity in capital structure decisions when planning future issuances.
• Flotation cost percentages vary by security type, deal size, market conditions, and issuer risk.

Simple explanation

Flotation costs are the fees and expenses a company pays to raise money by selling new shares. They lower the amount of money the company actually gets from the sale.

Related terms

• Flotation (going public): making company shares available to the public, often via an IPO.
• Flotation price: the price at which shares are first offered to the public; sometimes used to refer to the costs incurred to issue those shares.
• Main flotation cost: underwriting fees paid to investment banks are typically the largest single expense in an IPO (often 4–7% of gross proceeds).

Bottom line

Issuing new securities involves material upfront costs that reduce net proceeds and raise the effective cost of new equity. Accurately accounting for flotation costs—either by adjusting initial cash flows or by using an adjusted cost of new equity—is important when evaluating financing options and investment projects.