Trower Corp. has a debt-equity ratio of.85. The company is considering a new pla

Question

Trower 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 number, 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 number, e.g., 32.) 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 number, e.g., 32.)

Explanation / Answer

a. The floatation cost of new equity =7.7% = 0.077

The floatation cost of debt = 3.2% = 0.032

D/E ratio = 0.85

So D = 0.85 E , If E =1 , D =0.85

Hence weight of equity = 1/1.85 = 0.5405

Weight of debt = 1-0.5405 = 0.4595

The total linital cost with floation costs are =0.5405*107,000,000*(1+0.077) + 0.4595*107,000,000*(1+0.032) = 113,026,507.50

b. Since the company raised 65% through retained earning, there is no Cost.

So the amount raised through retained earnings = 0.65* 107,000,000 = 69,550,000

The remaining amount = 107,000,000 - 69,550,000 = 37,450,000

The total linital cost with floation costs are : 69,550,000 + 0.5405*37,450,000*1.077 + 0.4595*37,450,000*1.032 = $109,109,227.63

c. Since 100% is raised through retained earnings, there is no floatation cost. Hence inital cost = 107,000,000

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