Question

Edwards Construction currently has debt outstanding with a market value of $76,000 and a cost of 9 percent. The company has EBIT of $6,840 that is expected to continue in perpetuity. Assume there are no taxes.

  

a-1.	What is the value of the company's equity? (Do not round intermediate calculations. Leave no cell blank - be certain to enter "0" wherever required.)

  

Value of equity

______

  

a-2.	What is the debt-to-value ratio? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

Debt-to-value ratio

________

  

b.	What are the equity value and debt-to-value ratio if the company's growth rate is 3.5 percent? (Do not round intermediate calculations and round your "Debt-to-value" answer to 3 decimal places, e.g., 32.161.)

  

Equity value	$ _______
Debt-to-value	________

  

c.	What are the equity value and debt-to-value ratio if the company's growth rate is 5.5 percent? (Do not round intermediate calculations and round your "Debt-to-value" answer to 3 decimal places, e.g., 32.161.)

  

Equity value	$ _______
Debt-to-value	_______

Answer 1

a-1. Debt Value = 76000
Cost of Capital = 9%
Total Value of Firm = EBT/Cost of Capital = 6840/9% = 76,000

Value of Equity = 76000 - 76000 = 0

a-2. Debt to Value Ratio = 76000/76000 = 1

b. If growth = 3.5%
Value of firm = EBIT*(1+g)/(Cost of Capital - Growth) = 6840*(1+3.5%)/(9%-3.5%) = 128,716.36

Value of Equity =128,716.36 - 76000 = 52716.36
Debt to Value Ratio = 76000/128,716.36 = 0.590


c. If growth = 5.5%
Value of firm = EBIT*(1+g)/(Cost of Capital - Growth) = 6840*(1+5.5%)/(9%-5.5%) = 206,177.14

Value of Equity =206,177.14 - 76000 = 130,177.14
Debt to Value Ratio = 76000/206,177.14 = 0.369

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