The onstt.t0 Construction Company is a real estate developer and building contractor. The company has two sources of long-term capital: debt and equity. The cost of issuing debt is the after-tax cost of the interest that relates to the debt. (Interest paid on debt is tax deductible.) The cost of the company’s equity capital is the investment opportunity rate of Constructo investors. This is the rate that investors could earn on investments that are of similar risk to Constructo Construction. The interest rate on the company’s $90 million of long-term debt is 10 per cent per annum, and the company’s tax rate is 40 per cent. The market value of the long-term debt is the same as the carrying amount of the debt. The cost of the company’s equity capital is 15 per cents and the market value (and the book value) of the company’s equity is $135 million.
The following data relate to the two divisions of the Constructo Construction” Company for the past year:
1. Calculate the weighted average cost of capital of Constructo Construction Company.
2. Use the weighted average cost of capital to calculate the EVA® for each of the two divisions.