Sheaves Corp. has a debt?equity ratio of .85. The company is considering a new p
ID: 2727473 • Letter: S
Question
Sheaves Corp. has a debt?equity ratio of .85. The company is considering a new plant that will cost $120 million to build. When the company issues new equity, it incurs a flotation cost of 9 percent. The flotation cost on new debt is 4.5 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.)
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.)
What is the initial cost of the plant if the company typically uses 100 percent retained earnings?
Sheaves Corp. has a debt?equity ratio of .85. The company is considering a new plant that will cost $120 million to build. When the company issues new equity, it incurs a flotation cost of 9 percent. The flotation cost on new debt is 4.5 percent.
Explanation / Answer
A.
Initial cost of plant if conpany raises externally:
Total required fund: 120 million
Debt to equity is 0.85
Hence the debt fund for new plant will be 120/1.85*0.85 = 55.1351
Flotation cost for debt is 4.5% hence incurred cost of 2.4810 million
Equity to be externally brought of 64.8649 million
Cost of floutation @9% is $5.8378 million.
The initial cost of investment is $ 55.1351+ 2.4810 + 64.8649 + 5.8378 = $128.3188
B.
Initial cost of plant if conpany uses 65% retained earnings
Structure of equity for new plant: Total from equity as per debt to equity ratio is 0.85:1
Total equity is $ 64.8649
Out of this, 65% will be contributed from retained earning hence balance 35 % will be external equity valuing to $ 22.7027
Cost of floatationof external equity @9% is $ 2.0432
Retained earning to be used $ 64.8649*65%= 42.1621
Debt will be same as mentioned in part A answer
Total initial cost of investment will be 22.7027+2.0432+42.1621+55.1351+2.4810= $124.5241
C.
If company typically uses 100%retained earnings
Retained earning to be used $ 64.8649
Debt $ 55.1351
Cost floatation of debt @4.5% is ,$ 2.4810
Totalcost of investment will be $ 64.8649 + 55.1351 + 2.4810 = $122.4810
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