Question

Sheaves Corp. has a debt?equity ratio of .9. The company is considering a new plant that will cost $116 million to build. When the company issues new equity, it incurs a flotation cost of 8.6 percent. The flotation cost on new debt is 4.1 percent.

1)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 dollar
amount, e.g., 32.)**

2)What is the initial cost of the plant if the company typically
uses 60 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 dollar amount, e.g., 32.)**

3)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 dollar amount, e.g., 32.)**

Answer #1

1). Initial cost of the plant = $116 million * 1.086 =
**$125,976,000**

2). Debt to capital "D/C" = D/E / (1 + D/E) = 0.9 / 1.9 =
0.47368

thus, equity to capital is (1 - D/C) = 0.52632

cost financed from retained earnings: 116m * 0.6 =
$69,600,000

remainder to finance with new capital: 116m - 69.6m =
$46,400,000

if that amount is financed at the same debt and
equity proportions as the existing capital structure...

46,400,000 * 0.47368 = $21,978,752 needs to be raised from
debt,

thus the cost of that is: $21,978,752 * 1.041 = $22,879,880.83 and

46,400,000 * 0.52632 = $24,421,248 will need to be raised from new equity,

which will cost: 24,421,248 * 1.086 = $26,521,475.33

For a total cost of: 69,600,000 + 22,879,880.83 +
26,521,475.33 = **$119,001,356.20**

3). Initial cost of the plant = **$116
million**

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