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

EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN:9781337514835
Author:MOYER
Publisher:MOYER
Chapter3: Evaluation Of Financial Performance
Section: Chapter Questions
Problem 8P
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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                                                         
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