Epiphany is an all-equity firm with an estimated market value of $400,000.The firm sells $300,000 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.

Question

Quizplus · Accepted Answer

After the proposed financing and repurchase of equity, the market value of the firm remains unchanged at $400,000, but the amount of equity and debt change.

If the firm sells $300,000 of debt, then $300,000 of that $400,000 market value is debt. That leaves $100,000 in equity.

Weight in equity = $100,000 / $400,000 = 0.25 or 25%
Weight in debt = $300,000 / $400,000 = 0.75 or 75%

Therefore, the best choice is B.

Epiphany Is an All-Equity Firm with an Estimated Market Value