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 $60 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 15 percent. Moreover, the market value (and book value) of Golden Gate's equity is $90 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 Current Division Total Assets Liabilities Income Real estate $100,000,000 $6,000,000 $20, 000,000 Construction 60,000,000 4,000,000 18,000,000 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

Weighted Average cost of capital = after tax cost of debt + cost of Equity / Market Value of Debts

=. 6*60 + 15*90. /. 60+ 90

=. 11.40

Economic Value Added. =After tax Income -(Total assets - Current Liabilities) * WACC

Div 1: 12000000 - ((100000000-6000000)*11.40)

= 1284000

Div 2: 10800000- ((60000000-4000000)*11.40)

= 4416000

N4

Division After Tax operating income Total assets Current Liabilities WACC EVA Real Estate 12000000 100000000 6000000 11.40 1284000 Construction 10800000 60000000 4000000 11.40 4416000

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