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 $64 million of long-term debt is 10 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 $81 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 Total Assets $93, 000, 000 62, 900, 000 Current Liabilities $5, 100, 000 3, 400, 000 Division ? ??? eal estate Construction $21, 300, 000 18, 700, 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 (i.e. .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

DIVISION

EVA (in Millions)

Real Estate

$5.542

Construction

$6.321

Workings

Weighted Average Cost of capital

= [ (6 x 64) + (10 x 81)] / 145

= [384 + 810 ] / 145

= 8.234%

EVA = Investment center's after-tax operating income - ((Investment center's total asset - Investment center's current liabilities)*WACC)

EVA - Real Estate Division

= ($2,13,00,000 x 60%) – [ ($9,30,00,000 - $51,00,000) x 8.234%]

= $1,27,80,000 - $ 72,38,000

= $ 55,42,000

= $5.542 Million

EVA – Construction Division

= ($1,87,00,000 x 60%) – [ ($6,29,00,000 - $34,00,000) x 8.234%]

= $ 1,12,20,000 - $48,99,000

= $ 63,21,000

= $6.321 Million

DIVISION

EVA (in Millions)

Real Estate

$5.542

Construction

$6.321

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