Question

dwards Construction currently has debt outstanding with a market value of $86,000 and a cost of 7 percent. The company has EBIT of $6,020 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.) 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.) b. What are the equity value and debt-to-value ratio if the company's growth rate is 2 percent? (Do not round intermediate calculations and round your "Debt-to-value" answer to 3 decimal places, e.g., 32.161.) c. What are the equity value and debt-to-value ratio if the company's growth rate is 6 percent? (Do not round intermediate calculations and round your "Debt-to-value" answer to 3 decimal places, e.g., 32.161.)

Answer 1

a1. value of the company's equity = $0 [ EBIT is equal to debt payments i.e. 86000 *7% = 6020 , hence no equity value]

a-2.debt-to-value ratio = 1 [ 86000 / 86000 =1]

b. Earnings next year = 6020 * (1+2%) = 6140.4

Payment to shareholders = 6140.4 - 6020 = 120.4

Value of equity = 120.4 / ( 7% -2%) = $2408

Debt to value ratio = 86,000 / ( 86000+ 2408) =   0.973

c.

Earnings next year = 6020 * (1+6%) = 6381.2

Payment to shareholders = 6381.2 - 6020 = 361.2

Value of equity = 361.2 / ( 7% -6%) = $36120

Debt to value ratio = 86,000 / ( 86000+ 36120) =   0.704