In finance, as in accounting, the two sides of the balance sheet must be equal. we valued the asset side of the balance sheet. To value the other side, we must value the debt and the equity, and then add them together. as the firm levers up, how does the increase in value get apportioned between creditors and shareholders? Explain it 0% Debt/ 25% Debt/ 50% Debt/ 100% Equity 75% Equity 50% Equity Cash flow to creditors: Interest - $125 $250 Pretax cost of debt 5.0% 5.0% 5.0% Value of debt: (Int/Kd) Cash flow to shareholders: EBIT $1,485 $1,485 $1,485 Interest - $125 $250 Pretax profit Taxes (@ 34%) Net income + Depreciation $500 $500 $500 - Capital exp. ($500) ($500) ($500) + Change in net working capital - - - - Debt amortization - - - Residual cash flow Cost of equity Value of equity (RCF/Ke) Value of equity plus value of debt

In finance, as in accounting, the two sides of the balance sheet must be equal. we valued the asset side of the balance sheet. To value the other side, we must value the debt and the equity, and then add them together. as the firm levers up, how does the increase in value get apportioned between creditors and shareholders? Explain it 0% Debt/ 25% Debt/ 50% Debt/ 100% Equity 75% Equity 50% Equity Cash flow to creditors: Interest - $125 $250 Pretax cost of debt 5.0% 5.0% 5.0% Value of debt: (Int/Kd) Cash flow to shareholders: EBIT $1,485 $1,485 $1,485 Interest - $125 $250 Pretax profit Taxes (@ 34%) Net income + Depreciation $500 $500 $500 - Capital exp. ($500) ($500) ($500) + Change in net working capital - - - - Debt amortization - - - Residual cash flow Cost of equity Value of equity (RCF/Ke) Value of equity plus value of debt

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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	0% Debt/	25% Debt/	50% Debt/
	100% Equity	75% Equity	50% Equity

Cash flow to creditors:
Interest	-	$125	$250
Pretax cost of debt	5.0%	5.0%	5.0%
Value of debt:
(Int/K_d)

Cash flow to shareholders:
EBIT	$1,485	$1,485	$1,485
Interest	-	$125	$250
Pretax profit
Taxes (@ 34%)
Net income
+ Depreciation	$500	$500	$500
- Capital exp.	($500)	($500)	($500)
+ Change in net working capital	-	-	-
- Debt amortization	-	-	-
Residual cash flow

Cost of equity

Value of equity (RCF/K_e)

Value of equity plus value of debt

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