Reference no: EM132662148

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-TaxOperating Income

Real estate ..................... $100,000,000      $6,000,000                   $20,000,000

Construction .................... 60,000,000         4,000,000                      18,000,000

Required:

Question 1: Solve 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.)