Question

Sheaves Corp. has a debt?equity ratio of .85. The company is considering a new plant that will cost $107 million to build. When the company issues new equity, it incurs a flotation cost of 7.7 percent. The flotation cost on new debt is 3.2 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 dollar amount, e.g., 32.) Initial cash flow $ 113,026,508 What is the initial cost of the plant if the company typically uses 65 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.) 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 dollar amount, e.g., 32.)

Answer 1

A) What is the initial cost of the plant if the company raises all equity externally?

= $107,000,000 * (1+7.7%) = $115,239,000

B) What is the initial cost of the plant if the company typically uses 65 percent retained earnings?

Amount financed from retained earnings: $107,000,000 * 65% = $69,550,000

Remaining amount to be financed: $107,000,000 - $69,550,000 = $37,450,000

% of Debt = D/E / (1 + D/E) = 0.85 / 1.85 = 0.46 or 46%

% of Equity = 1 - % of Debt = 0.54 or 54%

weighted flotation cost = (3.2% * 0.46) + (7.7% * 0.54) = 0.01472 + 0.04158 = 0.0563

Remaining amount to be financed (with floatation costs) = $37,450,000 * (1+0.0563) = $39,558,435

Amount financed from retained earnings: $69,550,000

Total cost = $39,558,435 + $69,550,000 = $109,108,435

C) What is the initial cost of the plant if the company typically uses 100 percent retained earnings?

$107,000,000