Flotation costs are the legal, advisory, registration, underwriting and other transaction costs of raising new finance. In project appraisal, they are usually treated as an incremental initial cash outflow when the project causes the financing issue.
What flotation costs include
| Cost | Examples |
|---|---|
| Professional fees | Legal, accounting and advisory work |
| Issue administration | Registration, listing and documentation |
| Distribution | Underwriting, placement and brokerage commission |
| Communication | Prospectus and investor-marketing costs |
Why the treatment matters
If a project requires a new security issue, the business must raise more than the project's direct asset cost because part of the proceeds will pay issue expenses.
Worked example
A project needs net funds of 1,000,000 and the flotation-cost rate is 4%. Gross funds required are 1,000,000 ÷ 0.96 = 1,041,667. The flotation cash outflow is approximately 41,667.
Recommended cash-flow treatment
Include the incremental flotation amount in the time-zero project cash flow when the financing issue is caused by the project. Discount operating cash flows at a rate that reflects project risk and target financing, without adding the same issue cost again.
Alternative WACC adjustment
Some analyses increase a component cost or WACC to recover flotation costs. This can spread a one-time cost across all project years and may produce confusing results. If used, the method and assumptions should be stated clearly and tested against direct cash-flow treatment.
Issue costs may also differ by financing source. A mixed financing plan should estimate the incremental cash cost of each planned issue rather than applying one unsupported percentage to the entire project. Material estimates should be reconciled with actual adviser or underwriter information before approval.
Avoid double counting
- Do not add flotation costs to initial cash flow and also increase WACC for the same amount.
- Include only incremental costs caused by the financing decision.
- Distinguish new-issue costs from the normal cost of capital.
- Match tax treatment to applicable rules and evidence.
Decision checklist
| Question | Reason |
|---|---|
| Is new external finance required? | Existing retained funds may not trigger new-issue costs |
| Which costs are incremental? | Only project-caused cash flows belong in NPV |
| Are percentages based on gross or net proceeds? | The formula changes the required amount |
| Has the cost been counted elsewhere? | Prevents double counting |
Frequently asked questions
Are flotation costs part of normal WACC?
They are transaction costs of issuing finance, not the recurring required return itself.
Why gross up the funds required?
Because part of the gross proceeds is consumed by issue costs, leaving less for the project.
Can flotation costs be ignored?
Only when they are immaterial or not incremental to the project, with that judgment documented.
What is the main error?
Counting the same flotation cost in both initial cash flow and the discount rate.
Continue learning
- WACC formula and example
- Book versus market weights
- Investment appraisal methods
- Project cost of capital
Use the formulas and examples as learning tools. Real decisions should use reliable data, appropriate assumptions and professional judgment where necessary.
A new issue of debt or shares will invariable involves flotation costs in the form of legal fees, administration expenses, brokerage or underwriting commission. One approach is to adjust the flotation costs in the cancellation of the cost of capital.
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