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 $114 million to build. When the company issues new equity, it incurs a flotation cost of 8.4 percent. The flotation cost on new debt is 3.9 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 65 percent retained earnings?

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

Please round answer to two decimal places.

Sheaves Corp. has a debtequity ratio of .85. The company is considering a new plant that will cost $114 million to build. When the company issues new equity, it incurs a flotation cost of 8.4 percent. The flotation cost on new debt is 3.9 percent.

Explanation / Answer

1) a) Cost of Plant $114,000,000 Debt to Capital Ratio = D/E / (1 + D/E); 0.85/(1+.85) 45.95% Equity = (1- Debt to capital ratio); 1-45.95% 54.05% WACC = cost of debt x flotation cost) + (cost of equity x floation cost)( 1- % fund raised internally (45.95% x 3.9%) + (54.05% x 8.4%) x (1-0) 6.33% Amount Raised = (1-6.33%) = $114,0000 Initial Cash Flow = $114,000,000 / (1 - 6.33%) $121,707,014.46 b) Additional new capital financed in proportion to debt equity ratio, Debt to Capital Ratio = D/E / (1 + D/E); 0.85/(1+.85) 45.95% Equity = (1- Debt to capital ratio); 1-45.95% 54.05% WACC = cost of debt x flotation cost) + (cost of equity x floation cost)(1 - 65% ) = (45.95% x 3.9%) + ((54.05% x 8.4%)*(1-65%)) 3.38% Amount Raised = (1-3.38%) = $114,0000 Initial Cash Flow = $114,000,000 / (1 - 3.38%) $117,989,314.39 c. Debt to Capital Ratio = D/E / (1 + D/E); 0.85/(1+.85) 45.95% Equity = (1- Debt to capital ratio); 1-45.95% 54.05% WACC = cost of debt x flotation cost) + (cost of equity x floation cost)(1 - 65% ) = (45.95% x 3.9%) + ((54.05% x 8.4%)*(1-1)) 1.79% Amount Raised = (1-1.79%) = $114,0000 Initial Cash Flow = $114,000,000 / (1 - 1.79%) $116,080,028.62

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