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 $101 million to build. When the company issues new equity, it incurs a flotation cost of 7.1 percent. The flotation cost on new debt is 2.6 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 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.)

Initial cash flow $__________.

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.)

Initial cash flow $____________.

Explanation / Answer

Initial cost of the plant if the company raises all equity externally Cost of project * 1.071 In Million 108.171 Initial cost of the plant if the company typically uses 65 percent retained earnings Convert debt to equity TO debt to capital to calculate the weight of debt in the capital structure 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: 101m * 0.65 = 65,650,000 remainder to finance with new capital: 101m - 65.65m = 35,350,000 if that amount is financed at the same debt and equity proportions as the existing capital structure 35,350,000 * 0.45946 = 16,241,911 needs to be raised from debt, thus the cost of that is: 16,241,911 * 1.026 = 1666200.69 and 35,350,000 * 0.54054 = 19108089 will need to be raised from new equity, which will cost: 19,108,089 * 1.071 = 20464763.32 For a total cost of: 65,650,000 + 1666200.69 + 20464763.32 87780964.01 Initial cost of the plant if the company typically uses 100 percent retained earnings Cost financed from retained earnings: 101m * 1 = 101,000,000

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