Bay Corp. has a debt-equity ratio of (2/3). The company is considering a new plant that will cost $600 million to build. When the company issues new equity, it incurs a flotation cost of 8 percent. The flotation cost on new debt is 3 percent.
a. What is the initial cost of the plant if the company raises all equity externally (and funds the project with the company’s debt-equity ratio)?
b. What is the initial cost of the plant if the company raises 60 percent of the new equity required using retained earnings (and funds the project with the company’s debt-equity ratio)?