Exercise 13-27 Revised Golden Gate Construction Associates, a real estate develo

Question

Exercise 13-27 Revised 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 $80 million of long term debt is 10 percent, and the company's tax rate is 30 percent. The cost of Golden Gate's equity capital is 16 percent. Moreover, the market value (and book value) of Golden Gate's equity is $70 million. Required: Calculate Golden Gate Construction Associates weighted-average cost of capital.

Explanation / Answer

note:

after tax cost of debt = before tax cost * (1 -tax rate)

=>10% * ( 1 - 0.30)

=>7%.

the following table shows the calculation of WACC:

Source AMount Weight Cost Weight * cost equity $70 million ($70/ 150)=>0.46667 16% 7.46667 debt $80 million ($80/150)=>0.53333 7% 3.73333 $150 million WACC 11.20%

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