Define flotation costs and explain how they are used when estimating a

Define flotation costs and explain how they are used when estimating a firm’s yield-to-maturity.

What will be an ideal response?

ANSWER

Answer: Flotation costs are the costs incurred to sell a security. They are the fees charged by the investment banker to facilitate the issuance and sale of the bond. To determine the yield-to-maturity of a new issue of bonds, it is proper to use the bond selling price less the flotation cost as the net proceeds to the firm. The net proceeds become the price used in the equation to determine the yield-to-maturity.