Sheaves Corp. has a debtequity ratio of .9. The company is considering a new pla

Question

Sheaves Corp. has a debtequity ratio of .9. The company is considering a new plant that will cost $105 million to build. When the company issues new equity, it incurs a flotation cost of 7.5 percent. The flotation cost on new debt is 3 percent.

What is the initial cost of the plant if the company raises all equity externally?

What is the initial cost of the plant if the company typically uses 100 percent retained earnings?

What is the initial cost of the plant if the company raises all equity externally?

What is the initial cost of the plant if the company typically uses 60 percent retained earnings?

What is the initial cost of the plant if the company typically uses 100 percent retained earnings?

Problem 14-29 Flotation Costs [LO4] Sheaves Corp. has a debt-equity ratio of .9. The company is considering a new plant that will cost $105 million to build. When the company issues new equity, it incurs a flotation cost of 7.5 percent. The flotation cost on new debt is 3 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.) Initial cash flow What is the initial cost of the plant if the company typically uses 60 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.) Initial cash flow What is the initial cost of the plant if the company typically uses 100 percent retained eanings? (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.) Initial cash flow

Explanation / Answer

a) If the company raises all equity externally:

Debt/Equity = 0.9

Debt/(Debt + Equity)= 0.9/1.90 = 0.474 = 47.4%

Equity/(Debt + Equity) = 52.6%

Part of initial cost raised by debt = 49.77mn

Floatation cost on debt = 49.77*0.03 = 1.4931

Part of initial cost raised by equity = 55.23mn

Floatation cost on equity = 55.23*0.075 = 4.14225

Initial cost of the plant = 105 + 1.4931+4.14225 = $110.6353mn =$110635300

b) If the company uses 60% of the total equity raised is retained earnings(i.e. internal equity)

Floatation cost on equity = 55.23*40% * 7.5%= 1.6569mn ........ (Floatation cost of retained earnings will be 0; only 40% of the equity raised will have floatation cost)

Floatation cost on debt = 49.77*0.03 = 1.4931 .... (remains the same)

Initial cost of the plant= 105 + 1.6569+1.4931 = $108.15mn =$108150000

c) If the company uses 100% of the total equity raised is retained earnings(i.e. internal equity)

Floatation cost on equity = 0 ..... ( (Floatation cost of retained earnings will be 0)

Floatation cost on debt = 49.77*0.03 = 1.4931 .... (remains the same)

Initial cost of the plant= 105+1.4931 = $106.4931mn = $106493100

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