Trower Corp. has a debt-equity ratio of .80. The company is considering a new pl
ID: 2646511 • Letter: T
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 final answer to the nearest whole dollar amount.)
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 final answer to the nearest whole dollar amount.)
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 final answer to the nearest whole dollar amount.)
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.
Explanation / Answer
Brief Understanding about Flotation Cost
Flotation Cost is the cost incurred by a company when it issues new securities, It includes includes expenses such as underwriting fees, legal fees and registration fees etc.
Suppose company Issuing its each share at $100 and its flotation cost per share @ 3%, It means that company shall receive $97 (i.e. 100-3 flotation cost) in hand against each share issued
Explanation:
We have made decision making under given situation by applying above discussed basic concept related to flotation cost
In the solving the given case, the net amount to be received against issue of 1$ equity Share = (1-0.076) = $0.924
Statement Showing Initial Cost of Plant under Various Alternative
Fund Requirement: $ 106 million
Particulars
If Company raises fund by all equity
If the Company Raises the Fund Party by equity and partly by Retained Earnings
If the company Raises Fund Fully by Retained Earnings
Equity Issued Externally
100%
45%
0%
Retained Earnings Utilization
0%
55%
100%
Amount to be received through equity ($ in millions) (I)
114.719
{ 106*1/0.924}
51.623
{(106*45%) *1/0.924}
0.00
Amount to be received by Retained Earrings
($ in millions) (II)
0.00
58.30
{106*55%}
106.00
Initial Cost of Plant Under Each alternative
(I)+(II) = (III)
114.72
109.92
106.00
Particulars
If Company raises fund by all equity
If the Company Raises the Fund Party by equity and partly by Retained Earnings
If the company Raises Fund Fully by Retained Earnings
Equity Issued Externally
100%
45%
0%
Retained Earnings Utilization
0%
55%
100%
Amount to be received through equity ($ in millions) (I)
114.719
{ 106*1/0.924}
51.623
{(106*45%) *1/0.924}
0.00
Amount to be received by Retained Earrings
($ in millions) (II)
0.00
58.30
{106*55%}
106.00
Initial Cost of Plant Under Each alternative
(I)+(II) = (III)
114.72
109.92
106.00
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