Problem 14-29 Flotation Costs [LO4] Sheaves Corp. has a debtequity ratio of .9.
ID: 2727614 • Letter: P
Question
Problem 14-29 Flotation Costs [LO4]
Sheaves Corp. has a debtequity ratio of .9. The company is considering a new plant that will cost $113 million to build. When the company issues new equity, it incurs a flotation cost of 8.3 percent. The flotation cost on new debt is 3.8 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 dollar amount, e.g., 32.)
What is the initial cost of the plant if the company typically uses 60 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.)
Sheaves Corp. has a debtequity ratio of .9. The company is considering a new plant that will cost $113 million to build. When the company issues new equity, it incurs a flotation cost of 8.3 percent. The flotation cost on new debt is 3.8 percent.
Explanation / Answer
Total Cost of plant = $113 million
a.
Debt equity ratio = 0.9
Percentage of debt = 47.37%
Percentage of equity = 52.63%
Company using external source for financing the project. So total equity and debt required:
Equity required = $113 × 52.63%
= $59,471,900
Debt required = $113 × 47.37%
= $53,528,100
Flotation cost for equity is 8.3% and flotation cost for debt is 3.8%.
So total Equity issue = $59,471,900 / (1 – 8.3%)
= $64,854,853
Total debt Issue = = $53,528,100 / (1 – 3.8%)
= $55,642,516
Total initial cost of project = $64,854,853 + $55,642,516
= $120,497,369
Hence, Total initial cost in case of external funding is $120,497,369.
b.
Company uses 60% of retained earnings.
So total value of retained earning uses = $113,000,000 × 60%
= $67,800,000
Total value of retained earning uses = $67,800,000.
Total external funding uses = $113,000,000 - $67,800,000
= $45,200,000
Total external funding uses = $45,200,000
Debt equity ratio = 0.9
Percentage of debt = 47.37%
Percentage of equity = 52.63%
Company using external source for financing the project. So total equity and debt required:
Equity required = $45,200,000 × 52.63%
= $23,788,760
Debt required = $45,200,000 × 47.37%
= $21,411,240
Flotation cost for equity is 8.3% and flotation cost for debt is 3.8%.
So total Equity issue = $23,788,760 / (1 – 8.3%)
= $25,941,941
Total debt Issue = = $21,411,240 / (1 – 3.8%)
= $22,257,007
Total initial cost of project = $67,800,000 + $25,941,941 + $22,257,007
= $115,998,948
Hence, Total initial cost in case of 40% external funding is $115,998,948.
c.
Company uses 100% of retained earning for the project.
In case of 100% retained earning total initial cost of project will be same that is $113 million.