Question

Sheaves Corp. has a debt?equity ratio of .9. The company is considering a new plant that will cost $116 million to build. When the company issues new equity, it incurs a flotation cost of 8.6 percent. The flotation cost on new debt is 4.1 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 60 percent retained earnings?What is the initial cost of the plant if the company typically uses 100 percent retained earnings? PLEASE SHOW ME ALL WORK . Thank You !

Answer 1

Weight of equity = 1 / ( 1 + 0.9) = 0.5263

Weight of debt = 1 - 0.5263 = 0.4737

To find the portion of equity flotation costs, we can multiply the equity costs by the percentage of equity raised externally, which is one minus the percentage raised internally.

Weighted average flotation cost = 0.5263 * 0.086(1 - 0) + 0.4737 * 0.041

Weighted average flotation cost = 0.045262 + 0.019422

Weighted average flotation cost = 0.064684

Accounting for flotation cost:

Total initial cost( 1 - 0.064684) = 116,000,000

Total initial cost(0.935316) = 116,000,000

Total initial cost = 124,022,255.6

If the cpmpany uses, 60% retained earnings, flotation costs = 0.5263 * 0.086(1 - 0.6) + 0.4737 * 0.041

Flotation costs = 0.018105 + 0.019422

Flotation costs = 0.037527

Total initial cost( 1 - 0.037527) = 116,000,000

Total initial cost( 0.962473) = 116,000,000

Total initial cost = 120,522,861.4

If the company raises 100% internally generated equity:

Flotation costs = 0.5263 * 0.086(1 - 1) + 0.4737 * 0.041

Flotation costs = 0 + 0.019422

Flotation costs = 0.019422

Total initial cost( 1 - 0.019422) = 116,000,000

Total initial cost( 0.980578) = 116,000,000

Total initial cost = 118,297,575.5