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 $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? (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.)

Explanation / Answer

Answer 1

120 M * 1.09 => $130800000

Initial cost of the plant if the company raises all equity externally => $130800000

Answer 2

Debt to capital "D/C" => D/E / (1 + D/E) => 0.85 / 1.85 => 0.45946
thus, equity to capital is (1 - D/C) => 0.54054

cost financed from retained earnings: 120m * 0.65 => $78000000

remainder to finance with new capital: 120m - 78m = $42000000

if that amount is financed at the same debt and equity proportions as the existing capital structure =>

42000000 * 0.45946 => 19297320 needs to be raised from debt, thus the cost of that is:

19297320* 1.045 => $20165699.4

&

42000000 * 0.54054 = 22702680 will need to be raised from new equity, which will cost:
22702680* 1.09 => $24745921.2

TOTAL COST=> $24745921.2 + 20165699.4 + 78000000 => $122911620.6

Initial cost of the plant if the company typically uses 65 percent retained earnings => $122911620.6

Answer 3

Initial cost of the plant if the company typically uses 100 percent retained earnings => 120 Million.

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