Definition
Flotation (Floatation) Cost represents the total expenses that a company incurs when it issues new securities, whether stocks or bonds. These costs are necessary for the company to legally and effectively issue public offerings or raise capital through debt instruments. Flotation costs are usually expressed as a percentage of the total issue size and can vary based on the type of security being issued and the conditions of the market.
Examples
Stock Issuance:
- A technology company decides to raise $100 million by issuing new shares. The underwriting and legal fees amount to $5 million. Thus, the flotation cost is 5% of the fundraising amount.
Bond Issuance:
- A utilities company issues $200 million worth of bonds. The associated fees, including underwriting and registration, total $4 million. Hence, the flotation cost is 2% of the bond issue.
Frequently Asked Questions
What constitutes flotation costs?
Flotation costs include underwriting fees, legal fees, registration fees, audit fees, and general expenses related to issuing new securities.
Why are flotation costs important?
They affect the net proceeds from the issuance of securities and can significantly influence a company’s cost of capital.
How are flotation costs accounted for in financial statements?
Typically, flotation costs are deducted from the proceeds of the issue rather than being expensed directly.
Can flotation costs be avoided?
While they cannot be entirely avoided, companies can minimize flotation costs by negotiating better terms with underwriters and other service providers.
Do flotation costs vary between different types of securities?
Yes, flotation costs can vary significantly between issuing stocks and bonds due to different regulatory requirements and underwriting complexities.
Related Terms
Underwriting Fees
The compensation received by underwriters for managing the public issuance and distribution of securities.
Registration Fees
Fees paid to regulatory bodies for the legal authorization to issue new securities.
Cost of Capital
The cost of funds used for financing a business, including debt and equity.
Public Offering
The process of selling new securities to the public in order to raise capital.
Equity Financing
Raising capital through the sale of shares in a company.
Online References
- Investopedia: What are Flotation Costs?
- Corporate Finance Institute: Flotation Costs
Suggested Books for Further Studies
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, Franklin Allen, and Alex Edmans
- “Corporate Finance: The Core” by Jonathan Berk and Peter DeMarzo
- “Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions” by Joshua Rosenbaum and Joshua Pearl
Fundamentals of Flotation (Floatation) Cost: Corporate Finance Basics Quiz
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