Edwards Construction currently has debt outstanding with a market value of $92,0
ID: 2716772 • Letter: E
Question
Edwards Construction currently has debt outstanding with a market value of $92,000 and a cost of 7 percent. The company has EBIT of $6,440 that is expected to continue in perpetuity. Assume there are no taxes.
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.)
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))
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))
Edwards Construction currently has debt outstanding with a market value of $92,000 and a cost of 7 percent. The company has EBIT of $6,440 that is expected to continue in perpetuity. Assume there are no taxes.
Explanation / Answer
a1.The cost of equity is also assumed to be 7%
Hence value of equity = C/r = 6440/0.07 = 92,000
a2.Hence value of debt is 92,000, value of equity is 92000
Hence debt to value ratio = 92000/92000 =1
b. In this case ebit is growing at a rate of 2% .So the EBIT next year = 6440*(1.02) = 6568.8
Hence value of equity at growth rate of 2% is given by C/(r-g) where C 6568.8 r =0.07 and g =0.02
Value of equity = 6568.8/(0.07-0.02) = $131,376
Debt to value ratio = 92,000/131,376 = 0.7
c. In this case ebit is growing at a rate of 6% .So the EBIT next year = 6440*(1.06) = 6826.4
Hence value of equity at growth rate of 6% is given by C/(r-g) where C 6826.4 r =0.07 and g =0.06
Value of equity = 6826.4/(0.07-0.06) = $682,640
Debt to value ratio = 92,000/682,640 = 0.135
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