Edwards Construction currently has debt outstanding with a market value of $350,

Question

Edwards Construction currently has debt outstanding with a market value of $350,000 and a cost of 8 percent. The company has an EBIT of $28,000 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. 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 b. Assume that the company's growth rate is 2 percent. What is the value of the company’s equity and the debt-to-value ratio now? (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. Assume that the company's growth rate is 4 percent. What is the value of the company’s equity and the debt-to-value ratio now? (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

Explanation / Answer

(a) interest payments = 0.08 ($350,000) = $28,000
which is equal to the EBIT, nothing left to the shareholders. so therefore value of equity will be zero, because the shareholders are not going to get anything that implies that the share holders needs some return in the form of investment. market value of the company’s debt is $350,000, the total value of the firm is equal to the market value of debt and the debt to value ratio is 1.

(b) EBIT for next year = $28,000 * 1.02 = $28,560

less: Interst amount =($28,000)

Amount available to shareholders = $ 560

Value of equity = 560 / ( 0.08 - 0.02) = 9,333

Total value of firm = 350,000 + 9333 = 359,333

Debt / value = 350,000 / 359,333 = 0.974

(c)

EBIT for next year = $28,000 * 1.04 = $29,120

less: Interst amount   =($28,000)

Amount available to shareholders = $ 1,120

Value of equity = 560 / ( 0.08 - 0.04) = 28,000

Total value of firm = 350,000 + 28,000 = 378,000

Debt / value = 350,000 / 378,000 = 0.926

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