Epiphany is an all-equity firm with an estimated market value of $300,000. The firm sells $250,000 of debt and uses the proceeds to purchase outstanding equity. Compute the weight in equity and the weight in debt after the proposed financing and repurchase of equity

The answer is:

Weight in Equity is 0.17

Weight in debt is 0.83

Explanation:

Weight in equity is calculated by value of the equity divided by the market value of the company i.e

value of the equity÷market value of the company

While Weight of debt is calculated by value of the debt  divided by the market value of the company i.e

value of the debt÷market value of the company.

In this question, market value is $300,000

Value of debt is $250,000

Therefore value of equity = $300,000 - $250,000

=$50,000.

Weight in Equity is now:

$50,000÷ $300,000

=0.17

And

Weight in debt is now:

$250,000÷ $300,000

=0.83

After the proposed financing and repurchase of equity, the weight in equity is 0.17 and the weight in debt is 0.83.

Explanation:

Weight in equity refers to the proportion of contribution of equity to the total capital of the company. It is the ratio of the company’s equity market value to the addition of the equity and debt market values.

On the other hand, weight in debt is the proportion of contribution of debt to the total capital of the company. It is the ratio of the company’s debt market value to the addition of the equity and debt market values.

From the question, the sales of $250,000 debt and use of its proceeds to purchase outstanding equity reduce equity market value from $300,000 to $50,000 (i.e. $300,000 equity – 250,000 debt = $50,000 equity). However, the addition of the equity and debt market values still remains at $300,000 (i.e. 250,000 debt + $50,000 equity = $300,000 total equity and debt market values).

Based the above explanation, we have:

Weight in equity = $50,000/$300,000 = 0.17

Weight in equity = $250,000/$300,000 = 0.83

Therefore, after the proposed financing and repurchase of equity, the weight in equity is 0.17 and the weight in debt is 0.83.

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