Equity/Bond Cost with Floatation Cost

Finding the cost for any investment is an important factor before making decision on the investment. Floatation cost is nothing but including the risk factor when calculating the cost of the capital. The cost of the capital increases with increase in risk factor. Floatation cost is usually calculated by the company that is issuing the bond or equity. The floatation cost includes the registration cost, investment banker bill, underwriter bills, government fees etc.  The floatation cost can be determined by estimating the cash flow. It is the most simpler and possible way to determine the floatation cost. Other methods are quite complex. Floatation costs are not the one that happens every year. It is eventual cost. It happens only during the expansion period or else during the starting of a new business.

Floatation cost compromise of basically two elements they are,

• The compensation cost that investment banker. It is usually the cost difference between the rate at which the company issues the stock and the rate at which the investor buys it. This difference in cost is the fee for investment banker.
• The expense incurred by the issuer of the bonds/ equities in form of legal, accounting, printing, and other out-of-pocket expenses)

Now let us see some of the difference between the floatation cost for bonds and securities.

• The floatation cost for bonds are usually lower than for stocks. The company however prefers stocks for a simple reason the fund that can be raised out of stocks are more.
• The floatation cost remains the same in case of bonds and it does not vary with bond issue size. In case of security the floatation cost decreases with the size of the issue size. The smaller the issue size higher percentage will be the floatation cost. The reason behind this being the fact that the cost like legal fee and other expenses that comes under floating cost are almost fixed.
• The floatation costs in case of bonds to some extend vary with the organization which is issuing it. This is not the case in security.

The floatation cost needs to be considered by the issuer while issuing bonds or securities.

Question:

• What are the two basic elements in the calculation of floatation cost?
• What are the difference between floatation cost for a bond and security?