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Weighted average cost of capital and economic value added

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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?

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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.

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See Also This Related BrainMass Solution

Golden Gate Construction Associates: Calculate the economic value added (EVA) for each of Golden Gate Construction Associates'divisions.

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 $90 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 $135 million.

Calculate Golden Gate Construction Associates' weighted-average cost of capital.

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-tatx operating income for the most recent year are as follows:

Division Total Assets
Current
Liabilities
Before-Tax
Operating Income
Real estate .................................................................... $150,000,000 $9,000,000 $30,000,000
Construction ................................................................. 90,000,000 6,000,000 27,000,000

Calculate the economic value added (EVA) for each of Golden Gate Construction Associates' divisions.

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