Question

Problem 15-3 Capital Structure and Growth

Edwards Construction currently has debt outstanding with a market value of $440,000 and a cost of 7 percent. The company has an EBIT of $30,800 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 4 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. What is the value of the company’s equity and the debt-to-value ratio?

EBIT	30800
interest payments=440000*.07	30800
Profit before Tax	0

Cash Flow for Shareholder =0

Value of Equity =0

Hence Debt to value =440000/440000=1

Equity value	0
Debt-to-value	1

b. What is the equity value and the debt-to-value ratio if the company's growth rate is 2 percent?

EBIT 30800*1.02	31416
interest payments=440000*.07	30800
Profit before Tax	616

Payment to shareholders=616

Value of Equity =616/(7%-2%)=$12320

The Debt/Value Ratio = $440000/[$440000 + $12320]=97.28%

c. What is the equity value and the debt-to-value ratio if the company's growth rate is 4 percent?

EBIT 30800*1.04	32032
interest payments=440000*.07	30800
Profit before Tax	1232

ayment to shareholders=1232

Value of Equity =1232/(7%-4%)=$4106.67

The Debt/Value Ratio = $440000/[$440000 + $4106.67]=91.46%