Edwards Construction currently has debt outstanding with a market value of $300,

Question

Edwards Construction currently has debt outstanding with a market value of $300,000 and a cost of 8 percent. The company has an EBIT of $24,000 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 "o" wherever required. Round your debt-to-value answer to 3 decimal places, e.g., 32.161.) Equity value Debt-to- value 1.000 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.) Equity value 194,400.00 Debt-to- value .610 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.) Equity value 540,000.00 Debt-to- value .380 X

Explanation / Answer

a) Equity Value = Firm Value - Debt

Firm Value = EBIT / (WACC - g) = 24,000 / (8% - 0%) = 300,000

=> Equity Value = 0

=> Debt / Firm Value = 1

b) If g = 3%, Firm Value = 24,000 / (8% - 3%) = 480,000

=> Equity Value = 480,000 - 300,000 = 180,000

=> Debt / Value = 0.625

c) If g = 5%, Firm Value = 24,000 / (8% - 5%) = 800,000

=> Equity Value = 800,000 - 300,000 = 500,000

=> Debt / Value = 300,000 / 500,000 = 0.6

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