Question

Edwards Construction currently has debt outstanding with a market value of $410,000 and a cost of 4 percent. The company has an EBIT of $16,400 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 2 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 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

Answer 1

a) EBIT = 16,400
Interest = Debt * Cost of Debt = 410,000 * 0.04 = 16400
Hence Cash flow to Equity holders = EBIT- Interest = 16400 - 16400 = 0

Debt to Firm value = 410,000/410,000 = 1

b)  EBIT with growth = 16,400*(1+2%) = 16,728
Value of Fiirm = EBIT after growth/(Cost of Capital - Growrth) = 16728/(4%-2%) = 836,400
Value of Equity = 836,400 - 410,000 = 426,400

Debt to Firm value = 410,000/836,400 = 0.51

c) EBIT with growth = 16,400*(1+3%) = 16,892
Value of Fiirm = EBIT after growth/(Cost of Capital - Growrth) = 16,892/(4%-3%) = 1,689,200
Value of Equity = 1689200 - 410,000 = 1,279,200

Debt to Firm value = 410,000/1,279,200 = 0.32