Trower Corp. has a debt–equity ratio of .80. The company is considering a new pl

Question

Trower Corp. has a debt–equity ratio of .80. The company is considering a new plant that will cost $103 million to build. When the company issues new equity, it incurs a flotation cost of 7.3 percent. The flotation cost on new debt is 2.8 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 55 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.)

Trower Corp. has a debt–equity ratio of .80. The company is considering a new plant that will cost $103 million to build. When the company issues new equity, it incurs a flotation cost of 7.3 percent. The flotation cost on new debt is 2.8 percent.

Explanation / Answer

a) Cost of Plant $103,000,000 Debt to Capital Ratio = D/E / (1 + D/E); 0.80/(1+.80) 44.44% Equity = (1- Debt to capital ratio); 1-44.44% 55.56% Portion funded through debt = $103,000,000 x 44.44% $45,777,777.78 Flotation Cost on Debt = $45,777,777.78 x 2.8% $1,281,777.78 Portion Funded through Equity = ($103,000,000 - $45,777,777.78) x 7.3% = $4,177,222.22 Total Flotation Cost = $1281777.78 + $4,177,222 $5,459,000.00 Initial Cost = $103,000,000 + $5,459,000 $108,459,000.00 b) Cost financed from retained earnings $103,000,000 x 55% $56,650,000 Additional new capital ($103,000,000 - $56,650,000) $46,350,000 Additional new capital financed in proportion to debt equity ratio, Debt to Capital Ratio = D/E / (1 + D/E); 0.80/(1+.80) 44.44% Equity = (1- Debt to capital ratio); 1-44.44% 55.56% WACC = cost of debt x flotation cost) + (cost of equity x floation cost)( (44.44% x 2.8%) + (55.56% x 7.3%) 5.30% Cost of capital financed from debt and equity = $46,350,000 x (1+5.30% $48,806,550 Cost financed from retained earnings $103,000,000 x 55% $56,650,000 Initial cash flow = ($48,806,550 + $56,650,000) $105,456,550 c. Cost financed from retained earnings $103,000,000 x 100% $103,000,000 Initial Cash Flow $103,000,000

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