Question

Trower Corp. has a debt–equity ratio of .80. The company is considering a new plant that will cost $106 million to build. When the company issues new equity, it incurs a flotation cost of 7.6 percent. The flotation cost on new debt is 3.1 percent.

What is the initial cost of the plant if the company raises all equity externally? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Initial cash flow

$

What is the initial cost of the plant if the company typically uses 55 percent retained earnings? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Initial cash flow

$

What is the initial cost of the plant if the company typically uses 100 percent retained earnings? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Initial cash flow

$

Answer 1

1: Amount of New equity = $106 million* 100/180 = 5888 8888.89

Flotation cost = 7.6%* 58888888.89 = 4475555.56

Amount of debt = $106000000*80/100 =84800000

Flotation cost of debt = 84800000*3.1% =2628800

Initial cost of the plant = Purchase cost + Flotation cost

= 106000000+ 4475555.56+2628800

= 113104355.6

2: Amount of equity in the plant = $106 million* 100/180 = 58888888.89

Retained earnings = 55%*58888888.89 =32388888.89

New Equity = 45%* 58888888.89 = 26500000.00

Flotation cost = 7.6%* 26500000.00 = 2014000

Amount of debt = $106000000*80/100 =84800000

Flotation cost of debt = 84800000*3.1% =2628800

Initial cost of the plant = Purchase cost + Flotation cost

= 106000000+ 2014000+2628800

=110642800

3: In case of retained earnings there are no flotation costs of new equity,

Flotation cost of debt = 84800000*3.1% =2628800

Hence Initial cost of the plant = $106000000 +2628800=108628800