Golden Gate Construction Associates, a real estate developer and building contra

Question

Golden Gate Construction Associates, a real estate developer and building contractor in San Francisco, has two sources of long-term capital: debt and equity. The cost to Golden Gate of issuing debt is the after-tax cost of the interest payments on the debt, taking into account the fact that the interest payments are tax deductible. The cost of Golden Gate's equity capital is the investment opportunity rate of Golden Gate's investors, that is, the rate they could earn on investments of similar risk to that of investing in Golden Gate Construction Associates. The interest rate on Golden Gate's $65 million of long-term debt is 9 percent, and the company's tax rate is 40 percent. The cost of Golden Gate's equity capital is 10 percent. Moreover, the market value (and book value) of Golden Gate's equity is $88 million. The company has two divisions: the real estate division and the construction division. The divisions' total assets, current liabilities, and before-tax operating income for the most recent year are as follows Before-Tax Operating Income Current Total Assets Liabilities Division Real estate $91,000,000 $5,200,000 $21,400,000 Construction 61,900,000 3,400,000 18,200,000 Required Calculate the economic value added (EVA) for each of Golden Gate Construction Associates' divisions. (Round your weighted- average cost of capital to 3 decimal places (ie·123). Enter your answers in millions rounded to 3 decimal places (i.e. 1,234,000 should be entered as 1.234).) Economic value added in millions) Division Real Estate Construction

Explanation / Answer

Economic value added formula = Net opertaing profit after tax - (WACC x Capital Invested)

Step 1: Calculation of WACC (Weighted average cost of capital)

WACC = 8.022%

Step 2: Capital Invested

Capital invested = Total Assets - Current liabilities

Step 3: Net operating profit after tax

Step 4: Economic value added

Particulars Amount in millions Proportion Cost (after tax) Weighted cost Debt 65 0.43 9 - (9x40%) = 5.4% 2.322 Equity 88 0.57 10% 5.7 Total 153 1 8.022%

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