Question

# Sheaves Corp. has a debt?equity ratio of .85. The company is considering a new plant that...

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

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