Question

Breckinridger Corp. has a debt-equity ratio of .85. The company is considering a new plant that will cost $104 million to build. When the company issues new equity, it incurs a flotation cost of 7.4 percent. The flotation cost on new debt is 2.9 percent. a. What is the initial cost of the plant if the company raises all equity externally? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.) b. What is the initial cost of the plant if the company typically uses 65 percent retained earnings? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.) c. What is the initial cost of the plant if the company typically uses 100 percent retained earnings? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.) has

Answer 1

Equity weight = 1 / (1 + D/E) = 1 / (1 + 0.85) = 0.5405

Debt weight = 1 - 0.54 = 0.4595

a) Equity Required = 0.54 x 104 = 56.22m

Using new equity, total equity required = 56.22 / (1 - 7.4%) = $60,708,657

New Debt required = 0.4595 x 104 / (1 - 2.9%) = $49,210,900

=> Initial Cost = $109,919,557

b) New equity = 56.22m x (1 - 65%) = 19.67m

With flotation cost, new equity required = 19.67 / (1 - 7.4%) = $21,248,030

Total equity = 56.22m x 65% + 21.24m = $57,788,570

Debt = 49,210,900

=> Initial Cost = $106,999,470

c) With 100% retained earnings, initial cost = 56.22m + 49.21m = $105,427,116