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Weighted average cost of capital and economic value added

Maple Leaf Industries, headquartered in Toronto, is a multiproduct company with three divisions: Pacific
Division, Plains Division, and Atlantic Division. The company has two sources of long-term capital:
debt and equity. The interest rate on Maple Leafâ??s $400 million debt is 9 percent, and the companyâ??s tax
rate is 30 percent. The cost of Maple Leafâ??s equity capital is 12 percent. Moreover, the market value of
the companyâ??s equity is $600 million. (The book value of Maple Leafâ??s equity is $430 million, but that
amount does not reflect the current value of the companyâ??s assets or the value of intangible assets.)
The following data (in millions) pertains to Maple Leafâ??s three divisions.
Division
Before-Tax
Operating Income
Current
Liabilities
Total
Assets
Pacific .................................................. $14 $6 $ 70
Plains .................................................. 45 5 300
Atlantic ............................................... 48 9 480
Required:
1. Compute Maple Leaf's weighted-average cost of capital (WACC).
2. Compute the economic value added (or EVA) for each of the company's three divisions.
3. What conclusions can you draw from the EVA analysis?

Solution Preview

1. rd=9% wd=400 million / (400 million + 600 million ) = 0.4 Tax=30%
re=12%, we=600 million/ (400 million + 600 million ) = 0.6
WACC = wd*rd*(1-tax) + we*re=0.4*9%*(1-30%)+0.6*12%=9.72%

2. EVA =
Invested capital = Total assets - non-interest-bearing liabilities (NIBL)
where ...

Solution Summary

This post shows how to calculate weighted average cost of capital and economic value added. It discusses the conclusion of the EVA analysis.

$2.19