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Lucas Corp has a debt-equity ratio of 85 The company is considering a new plant that will cost $104 million to build
Lucas Corp has a debt-equity ratio of 85 The company is considering a new plant that will cost $104 million to build. When the company issues new equity, it incurs a flotation cost of 7.4 percent. The flotation cost on new debt is 2.9 percent. a. What is the initial cost of the plant if the company raises all equity externally? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole dollar amount, e.g., 1,234,567.) b. What is the initial cost of the plant if the company typically uses 65 percent retained earnings? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole dollar amount, e.g., 1,234,567.) c. What is the initial cost of the plant if the company typically uses 100 percent retained earnings? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole dollar amount, e.g., 1,234,567.) a. b. Initial cash flow Initial cash flow Initial cash flow c.
Expert Solution
1) Weight of equity = 1 / (1 + 0.85) = 0.5405
Weight of debt = 1 - 0.5405 = 0.4595
WACC = Weight OF debt*flotation cost + weight of equity*flotation cost(1 - funds raised internally)
WACC = 0.4595*0.029 + 0.5405*0.074(1 - 0)
WACC = 0.013333 + 0.04
WACC = 0.05333 or 5.333%
Initial cash flow = Cost / (1 - WACC)
Initial cash flow = 104,000,000 / (1 - 0.05333)
Initial cash flow = 109,858,768
2)
Weight of equity = 1 / (1 + 0.85) = 0.5405
Weight of debt = 1 - 0.5405 = 0.4595
WACC = Weight OF debt*flotation cost + weight of equity*flotation cost(1 - funds raised internally)
WACC = 0.4595*0.029 + 0.5405*0.074(1 - 0.65)
WACC = 0.013333 + 0.014
WACC = 0.02733 or 2.733%
Initial cash flow = Cost / (1 - WACC)
Initial cash flow = 104,000,000 / (1 - 0.02733)
Initial cash flow = 106,922,183
3)
Weight of equity = 1 / (1 + 0.85) = 0.5405
Weight of debt = 1 - 0.5405 = 0.4595
WACC = Weight OF debt*flotation cost + weight of equity*flotation cost(1 - funds raised internally)
WACC = 0.4595*0.029 + 0.5405*0.074(1 - 1)
WACC = 0.013333 + 0
WACC = 0.013333 or 1.3333%
Initial cash flow = Cost / (1 - WACC)
Initial cash flow = 104,000,000 / (1 - 0.013333)
Initial cash flow = 105,405,370
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