Question

Edwards Construction currently has debt outstanding with a market value of $450,000 and a cost of 8 percent. The company has an EBIT of $36,000 that is expected to continue in perpetuity. Assume there are no taxes.

a. What is the value of the company’s equity and the debt-to-value ratio? (Do not round intermediate calculations. Leave no cells blank - be certain to enter "0" wherever required. Round your debt-to-value answer to 3 decimal places, e.g., 32.161.)

Equity value	$
Debt-to-value

b. What is the equity value and the debt-to-value ratio if the company's growth rate is 3 percent? (Do not round intermediate calculations. Round your equity value to 2 decimal places, e.g., 32.16, and round your debt-to-value answer to 3 decimal places, e.g., 32.161.)

Equity value	$
Debt-to-value

c. What is the equity value and the debt-to-value ratio if the company's growth rate is 5 percent? (Do not round intermediate calculations. Round your equity value to 2 decimal places, e.g., 32.16, and round your debt-to-value answer to 3 decimal places, e.g., 32.161.)

Equity value	$
Debt-to-value

Answer 1

Solution:

(a) Total value of firm = EBIT / K

= 36,000/ 8%

= $450,000

Equity value = Total value of firm - Debt

= $450,000 - $450,000

= 0.

Debt to value = Debt / Total value of firm

= $450,000 / $450,000

= 1

(b.)

Total value of firm = EBIT(1+ growth) / (K - growth)

= 36,000(1+ 0.03) / (8%-3%)

= $741,600

Equity value = Total value of firm - Debt

= $741,600 - $450,000

= $291,600.

Debt to value = Debt / Total value of firm

= $450,000 / $741,600

= 0.607

(c)  Total value of firm = EBIT(1+ growth) / (K- growth)

= 36,000/ (8%- 5%)

= $1,260,000

Equity value = Total value of firm - Debt

= $1,260,000 - $450,000

= $810,000

Debt to value = Debt / Total value of firm

= $450,000 / $1,260,000

= 0.357