Respuesta :
There are 3 questions that need to be solved.
a. The debt-to-value ratio for Edwards construction is 1 (based on $6,750 company EBIT, market value of $67,000 and a WACC of 10%).
b. The equity value if the company's growth rate at 2% is $18,562.5
The debt-to-value ratio if the company's growth rate at 2% is 0.784.
c. The equity value if the company's growth rate at 4%
The debt-to-value ratio if the company's growth rate at 4% is 0.576
What is EBIT?
EBIT stands for Earning Before Interest and Taxes. It is a common measure of a company's operating profitability. As its name suggests, EBIT is net income excluding the effect of debt interest and taxes. Both of these costs are real cash expenses, but they are not directly generated by the company's core business operations.
Now, let's answer the question.
a. From the question given
Market value = $67,000
WACC = 10%
EBIT = $6,750
Interest payment = Market value * WACC
= $67,000 * 10%
= $6,700
So, Cash flow to shareholders = EBIT - interest paid
= $6,750 - $6,700
= $50
Debt to value ratio = Total debt / Total value of firm
As there is no default, then total debt = total value of firm
So, the debt-to-value ratio of Edward's construction company is 67,000/67,000 = 1
b. the equity value and debt-to value ratio at growth rate 2%
EBIT for next year = EBIT + (1 + growth rate)
= $6,750 * (1 + 0.02)
= $6,885
Since there will be no risk the required return for any shareholder, then it will be equal as the return on company's debt.
Payment made to shareholders will increase by 2%
Value of equity = total assets - total liabilities
Value of equity = EBIT next year / (WACC - growth rate) - (EBIT / WACC)
= $6,885 / (10%-2%) - ($6,750 / 10%)
= 86,062.5 - 67,500
= $18,562.5
Debt to value ratio = total liabilities / (total liabilities + value of equity)
= $67,500 / (67,500 + 18,562.5)
= 0.784
c. the equity value and debt-to value ratio at growth rate 4%
EBIT for next year = $6,750 * (1 + 0.04) = $7,020
So, value of equity = total assets - total liabilities
= EBIT next year / (WACC - growth rate) - (EBIT / WACC)
= $7,020 / (10% - 4%) - ($6,750 / 10%)
= $117,000 - $67,500
= $49,500
debt to value ratio = total liabilities / (total liabilities + value of equity)
= $67,500 / ($67,500 + $49,500)
= $67,500 / $117,000
= 0.576
Learn more about EBIT https://brainly.com/question/19672958
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