Edwards Construction currently has debt outstanding with a market value of $101,000 and a cost of 10 percent. The company has EBIT of $10,100 that is expected to continue in perpetuity. Assume there are no taxes. a-1. What is the value of the company's equity? (Do not round intermediate calculations. Leave no cell blank - be certain to enter "0" wherever required.) a-2. What is the debt-to-value ratio? (Do not round intermediate calculations and round your answer to the nearest whole number, e. g., 32.) b. What are the equity value and debt-to-value ratio if the company's growth rate is 2 percent? (Do not round intermediate calculations and round your "Debt-to-value" answer to 3 decimal places, e. g., 32.161.) c. What are the equity value and debt-to-value ratio if the company's growth rate is 6 percent? (Do not round intermediate calculations and round your "Debt-to-value" answer to 3 decimal places, e. g., 32.161.)

Question

Business

Sterling Quinn

7 February, 03:01

Edwards Construction currently has debt outstanding with a market value of $101,000 and a cost of 10 percent. The company has EBIT of $10,100 that is expected to continue in perpetuity. Assume there are no taxes. a-1. What is the value of the company's equity? (Do not round intermediate calculations. Leave no cell blank - be certain to enter "0" wherever required.) a-2. What is the debt-to-value ratio? (Do not round intermediate calculations and round your answer to the nearest whole number, e. g., 32.) b. What are the equity value and debt-to-value ratio if the company's growth rate is 2 percent? (Do not round intermediate calculations and round your "Debt-to-value" answer to 3 decimal places, e. g., 32.161.) c. What are the equity value and debt-to-value ratio if the company's growth rate is 6 percent? (Do not round intermediate calculations and round your "Debt-to-value" answer to 3 decimal places, e. g., 32.161.)

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Answers (1)

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Nelson Garner · Answer 1

(a) (i) 0

(ii) 1

(b) $27,775; 0.784

(c) $166,650; 0.377

Explanation:

a-1)

Interest paid = market value of debt * cost

= $101,000 * 0.1

= $10,100

EBIT = $10,100

Cash flow to shareholders = EBIT - Interest paid

= $10,100 - $10,100

= 0

value of equity = 0

a-2)

Debt to value = total debt : total value of firm

total debt value debt is $101,000

No default is likely to occur

Hence, total value of firm = total debt

= $101,000

Hence, the debt to value ratio is 1.

(b) At growth rate 2%

EBIT next year will be:

= $10,100 * (1.02)

= $10,302

Since there is no risk, the required return for shareholders is the same as the required return on the company's debt.

The payments made to the shareholders increase at 2% every year.

Present value of these payments:

Value of equity = [ $10,302 : (0.1 - 0.02) ] - [$10,100 : 0.1]

= $128,775 - $101,000

= $27,775

Debt to value ratio = $101,000 : ($101,000 + $27,775)

= 0.784

(c) At growth rate of 6%

EBIT next year will be:

= $10,100 * (1.06)

= $10,706

Present value of these payments:

Value of equity = [ $10,706 : (0.1 - 0.06) ] - [$10,100 : 0.1]

= $267,650 - $101,000

= $166,650

Debt to value ratio = $101,000 : ($101,000 + $166,650)

= 0.377