What is Flotation Cost

Flotation cost is the total cost of issuing and selling a security. It reduces the net proceeds from the sale. Flotation cost has two components

i) Underwriting costs
ii) Administrative costs

i) Underwriting costs :- Compensation earned by the investment bankers for selling security.


ii) Administrative costs :- Issuers expenses like - legal, Accounting, Printing and other expenses.

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'Is equity capital free of cost'

Because of the following reasons equity capital is not free of cost.

• Common stockholders can claim on the residual income of a company and have the right to interfere to the company's various internal matters.
• If all the profit is distributed to the shareholders then the company needs to issue additional shares for financing. 
• If the company decides to issue new shares then it will have to pay flotation cost.

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'Debt is the cheapest source of capital'

'Debt is the cheapest source of capital' - We can give comment on this statement from both lender and borrower point of view.

From Lender point of view :-

• Lenders feel secure because the obligation of bondholders meet before both preferred and common stockholders in case of company's liquidation.
• The interest against bonds must be paid to bondholders either the company makes profit or not.

From Borrower point of view :- 

• The main advantage of using debt instruments as a source of financing is the interest against debt instruments is tax deductible expenses. So the company can enjoy a tax reduction.
• The required rate of return of lenders is lower than other financing instruments. So the cost of debt or the cost of capital is lower for the company.
• Common stockholders can claim on the residual income of a company and have the right to interfere to the company's various internal matters but bondholders have not such right.

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