Flotation cost is an economic concept that describes the costs sustained by a firm when it issues out given security to the public. The issuing company usually incur several expenses such as legal charges and also registration charges. As a result, firms need to take into account the effects these charges will have on the amount of capital raised from a new issue. Due to this, companies usually consider hiring lawyers who offer advice on legal matters and need to register with relevant regulators like the SEC and exchange. Thus, concerning the above, the paper will explain why debt's flotation costs are expected to be significantly lower than equity’s flotation costs.
Companies usually have different ways of obtaining capital. Some use debts, while others use equity. Companies use debts when interest rates are low. This is generally because the interests paid on debts are tax-deductible, yet equity returns are not. On the other hand, some firms opt to use equity since it does not require any payback. As a result, flotation costs tend to be high for small issues of inferior companies and low for big issues in superior companies. This explains why flotation costs for debts are significantly lower than those for equity since many opt for equity to avoid extra payments. As a result, many investing firms will choose to go for equity since it does not require any payback, while debts will require paybacks.
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Conclusively, flotation costs are of great importance since a company's total issues amount depends on them. This provides the reason as to why flotation costs should be perceived as being part of an investment starter. Also, flotation costs have several limitations. For instance, the inclusion of flotation costs in a firm's equity costs means that they are an ongoing expense; thus, making equity's flotation cost higher than the flotation cost for debt.
