Sheaves Corp. has a debt-equity ratio of .9. The company is considering a new plant that will...

Question:

Sheaves Corp. has a debt-equity ratio of .9. The company is considering a new plant that will cost $108 million to build. When the company issues new equity, it incurs a flotation cost of 7.8 percent. The flotation cost on new debt is 3.3 percent.

1. What is the initial cost of the plant if the company raises all equity externally?

2. What is the initial cost of the plant if the company typically uses 60 percent retained earnings?

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

Weighted Average Flotation Cost:

Firms can raise external capital by issuing new debts or new equities. In either case, they incur flotation costs, which are expenses related to the issuance of new securities. Flotation costs include underwriting fees, legal fees, and other transaction costs. When evaluating investments, these flotation costs need to be added to produce a more accurate estimate of the project's profitability.

Answer and Explanation:

1. If the company raise all equity externally, they will incur the flotation costs. Given a debt-equity ratio of 0.9, the share of equity raise...

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Cost of Capital: Flotation Cost, NPV & Internal Equity

from Corporate Finance: Help & Review

Chapter 3 / Lesson 18
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