Energy Efficiency Consulting (EEC) has three offices. The corporation has a debt
ID: 2796190 • Letter: E
Question
Energy Efficiency Consulting (EEC) has three offices. The corporation has a debt-equity ratio 40 percent and makes interest payments $123,000 at the end of each year. The firm’s current equity cost of capital is 19 percent. Each of EEC’s offices estimates annual sales of $1.3 million, annual cost of goods sold of $670,000, and annual total general and administrative costs $405,000. The corporate tax rate is 40%.
If you assume these business conditions will remain the same forever, what is the value of the company's equity according to the flow to equity approach to valuation?
A. None of these values are correct.Explanation / Answer
Net Income = (Sales - Costs - SGA - Interest) x (1 - tax rate)
= (1,300,000 - 670,000 - 405,000 - 123,000) x (1 - 40%)
= $61,200
Value of firm's equity = Net Income / Cost of equity = 61,200 / 19% = $322,105
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