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 $117 million to build. When the company issues new equity, it incurs a flotation cost of 8.7 percent. The flotation cost on new debt is 4.2 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.)

NO EXCEL SOLUTIONS PLEASE!

Sheaves Corp. has a debtequity ratio of .85. The company is considering a new plant that will cost $117 million to build. When the company issues new equity, it incurs a flotation cost of 8.7 percent. The flotation cost on new debt is 4.2 percent.

Explanation / Answer

Debt Ratio, wd = D/E / (1 + D/E) = 0.85 / (1 + 0.85) = 46%

Equity Ratio, we = 1 - wd = 1 - 46% = 54%

Debt Required = 117 x 46% = $53.76 million

Equity Required = 117 - 53.82 = $63.24 million

a) With Flotation cost of 4.2%, debt capital raised = 53.76 x (1 + 4.2%) = $56,014,541

If 100% equity is raised externally with 8.7% flotation cost, equity capital raised = 63.24 x (1 + 8.7%) = $68,745,405

Initial Cost = $124,759,946

b) With 65% retained earnings, only 35% of equity will be newly raised, i.e. 35% x 63.24 = $22.135 million,

and retained earnings = $63.24 x 65% = $41.108m

With flotation cost, new equity raised = $22.135m x (1 + 8.7%) = $24,060,892

Initial Cost = $121,183,541

c) With 100% retained earnings,

initial cost = $63,243,243 + $56,014,541 = $119,257,784

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