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 6 percent, and the company's tax rate is 30 percent. The cost of Golden Gate's equity capital is 15 percent. Moreover, the market value (and book value) of Golden Gate's equity is $86 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 tollows: Before-Tax Operating Income Current Division Real estate $97,000,000 $5,700,000 $20,200,000 Construction 65,000,000 Total Assets Liabilities 3,900,000 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

$4.69 Million

Construction

$6.766 Million

Workings

Weighted Average Cost of capital

= [ (4.2% x 65) / 151 ] + [ (15% x 86)] / 151 ]

= 10.35%

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

EVA - Real Estate Division

= ($2,02,00,000 x 70%) – [ ($9,70,00,000 - $57,00,000) x 10.35%]

= $46,90,000

= $4.69 Million

EVA – Construction Division

= ($1,87,00,000 x 70%) – [ ($6,50,00,000 - $39,00,000) x 10.35%]

= $67,66,000

= $6.766 Million

DIVISION

EVA (in Millions)

Real Estate

$4.69 Million

Construction

$6.766 Million

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