Question

Edwards Construction currently has debt outstanding with a market value of $430,000 and a cost of 6 percent. The company has an EBIT of $25,800 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.)

Equity value	$
Debt-to-value

b. What is the equity value and the debt-to-value ratio if the company's growth rate is 4 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	$
Debt-to-value

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	$
Debt-to-value

Answer 1

a.
Equity value: $0.00
Debt-to-value: 1.000

Reasons:
EBIT: $25,800
Less: Interest: $25,800 [being 6% of $430,000]
Earnings available to equity holders: $0 [$25,800-$25,800]

As no cash is available to equity holders, equity value can be taken as 0.
Debt-to-value = Value of Debt/(Value of Debt + Value of equity] = $430,000/($430,000+0) = 1

b.
Equity value: $51,600.00
Debt-to-value: 0.893

Reasons:
EBIT: $26,832 [being 25800x1.04]
Less: Interest: $25,800 [being 6% of $430,000]
Earnings available to equity holders: $1,032 [$26,832-$25,800]

So, equity value = 1032/(6%-4%) = $51,600
Debt-to-value = Value of Debt/(Value of Debt + Value of equity] = $430,000/($430,000+$51,600) = 0.893

c.
Equity value: $129,000.00
Debt-to-value: 0.769

Reasons:
EBIT: $27,090 [being 25800x1.05]
Less: Interest: $25,800 [being 6% of $430,000]
Earnings available to equity holders: $1,290 [$27,090-$25,800]

So, equity value = 1290/(6%-5%) = $129,000
Debt-to-value = Value of Debt/(Value of Debt + Value of equity] = $430,000/($430,000+$129,000) = 0.769

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