In: Accounting
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:
Division | Total Assets | Current Liabilities | Before-Tax Operating 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)).
Please find below table useful to compute desired results: -
End results would be as follows: -