13-27
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.
Required: Calculate Golden Gate Construction Associates weighted-average cost of capital.
13-28
Refer to the data in the preceding exercise for Golden Gate Construction Associates. 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: Division Total Assets Current Before-Tax Operating Income Liabilities 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. (You will need to use the weighted-average cost of capital, which was computed in the preceding exercise.)