Sheaves Corp. has a debtequity ratio of .85. The company is considering a new pl

Question

Sheaves Corp. has a debtequity ratio of .85. The company is considering a new plant that will cost $104 million to build. When the company issues new equity, it incurs a flotation cost of 7.4 percent. The flotation cost on new debt is 2.9 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? (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.)

Sheaves Corp. has a debtequity ratio of .85. The company is considering a new plant that will cost $104 million to build. When the company issues new equity, it incurs a flotation cost of 7.4 percent. The flotation cost on new debt is 2.9 percent.

Explanation / Answer

Answer a) The intial cost of plant if all equity is used

104 x (1.074) = 111.696

Answer b) We need to calculate the weight of debt in the capital structure

Weight of debt = D/E / (1+D/E) = 0.85 / (1+0.85) = 0.45945

Weight of equity = (1-debt) = 1-0.45945) = 0.540540

cost financed from retained earnings: 104m * 0.65 = 67,600,000
remainder to finance with new capital: 104m - 67.6m = 36,400,000

if that amount is financed at the same debt and equity proportions as the existing capital structure...
36,400,000 * 0.45946 = 16,724,324.32

needs to be raised from debt, thus the cost of that is:
16,724,324.32 * 1.029 = 17209329.73

and

36,400,000 * 0.54054 = 19675675.68  will need to be raised from new equity, which will cost:
19675675.68 * 1.074 = 21131675.68

For a total cost of = 67,600,000 + 17209329.73 + 21131675.68 = 105941005.41

Answer c) That will be 104 million

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