Edwards Construction currently has debt outstanding with a market value of $450,
ID: 2401038 • Letter: E
Question
Edwards Construction currently has debt outstanding with a market value of $450,000 and a cost of 8 percent. The company has an EBIT of $36,000 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.)
b. 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.)
c. What is the equity value and the debt-to-value ratio if the company's growth rate is 5 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.)
Explanation / Answer
Solution:
(a) Total value of firm = EBIT / K
= 36,000/ 8%
= $450,000
Equity value = Total value of firm - Debt
= $450,000 - $450,000
= 0.
Debt to value = Debt / Total value of firm
= $450,000 / $450,000
= 1
(b.)
Total value of firm = EBIT(1+ growth) / (K - growth)
= 36,000(1+ 0.03) / (8%-3%)
= $741,600
Equity value = Total value of firm - Debt
= $741,600 - $450,000
= $291,600.
Debt to value = Debt / Total value of firm
= $450,000 / $741,600
= 0.607
(c) Total value of firm = EBIT(1+ growth) / (K- growth)
= 36,000/ (8%- 5%)
= $1,260,000
Equity value = Total value of firm - Debt
= $1,260,000 - $450,000
= $810,000
Debt to value = Debt / Total value of firm
= $450,000 / $1,260,000
= 0.357
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