Question

*** make sure the answer isn't the same one that has. been answered under the same questions as they're all wrong.

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.)
  

Equity value	$
Debt-to-value

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	$
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). Value of Equity = $0

Value of the company = Value of the stock + value of debt

= 0 + 450,000

= $450,000

Debt to value ratio = Debt/Value

= $450,000/$450,000 = 1

b). Interest payment on debt = ($450,000*0.08) = $36,000

If the growth rate is 3% then EBIT of next year = $36,000(1+.03) = $37,080

Cash available for shareholders = $37,080 - $36,000 = $1,080

Since there is no risk, cost of equity should be equal to the cost of debt. Cash available to shareholders has growth rate of 3%. According to growing perpetuity,

value of equity = $1,080/(0.08 - 0.03) = $21,600

Value of the company = $450,000 + $21,600 = $471,600

Debt to value ratio = Debt/Value = $450,000 / $471,600 = 0.954

c). Interest payment on debt = ($450,000*0.08) = $36,000

If the growth rate is 5% then EBIT of next year = $36,000(1+.05) = $37,800

Cash available for shareholders = $37,800 - $36,000 = $1,800

Since there is no risk, cost of equity should be equal to the cost of debt. Cash available to shareholders has growth rate of 5%. According to growing perpetuity,

value of equity = $1,800/(0.08 - 0.05) = $60,000

Value of the company = $450,000 + $60,000 = $510,000

Debt to value ratio = Debt/Value = $450,000 / $510,000 = 0.882