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

EBIT = $6,840

Cost = 9%

Market Value of company = 6,840/9% = $76,000

Market Value of Debt = 76,000

a-1 Hence, Market Value of Equity = $0

a-2 Debt to Value Ratio = Debt/Market Value

= 76,000/76,000

= 1

B Growth Rate is 3.5%

Value of Company = EBIT(1+g)/(Cost of capital – growth rate)

= 6,840(1+0.035)/(0.09-0.035)

= $108,913.85

Value of Debt = 76,000

Hence, Value of Equity = $32,913.85

Debt to Value Ratio = 0.698

c.Growth Rate = 5.5%

Value of Company = EBIT(1+g)/(Cost of capital – growth rate)

= 6,840(1+0.055)/(0.09-0.055)

= $160,360

Value of Debt = 76,000

Hence, Value of Equity = $84,360

Debt to Value Ratio = 76,000/160,360 = 0.474