Capital Structure Growth
Edwards Construction currently has debt outstanding with a market value of $80,000 and cost of 12%. The company has an EBIT rate of $9,600 that is expected to continue in perpetuity. Assume there are no taxes
a. What is the value of the company's equity? What is the debt-to-value ratio?
b. What are the equity value and debt-to-value ratio if the company's growth rate is 5%?
c. What are the equity value and debt-to-value ratio if the company's growth rate is 10%?
a) EBIT = 9600
Interest = 80000*12%=9600
Tax @ 0%=0
Earnings after tax available to shareholders= 0
Since no cash is available for shareholders, the value of equity will be 0.
Value of the company's equity = 0
Debt to value ratio = ...
Shows how to calculate the value of a zero growth firm as well as that for a growing firm and how to work out the proportion of debt and equity in such a scenario. Could be used as a good practice exercise to understand for linkage between growth of the firm and its capital structure.