The following data pertain to Darwin Industries: Interest rate on debt capital: 9%Cost of equity capital: 12%Before-tax operating income: $35 millionMarket value of debt capital: $60 millionMarket value of equity capital: $120 millionTotal assets: $150 millionIncome tax rate: 30%Total current liabilities: $15 millionRequired: A. Compute Darwin's weighted-average cost of capital.B. Compute Darwin's economic value added.C. Briefly explain the meaning of economic value added.
What will be an ideal response?
A. WACC = [(9% × 70%) × $60,000,000) + (12% × $120,000,000)] ÷ ($60,000,000 + $120,000,000)
WACC = ($3,780,000 + $14,400,000) ÷ $180,000,000
WACC = 10.1%
B. EVA = ($35,000,000 × 70%) - [($150,000,000 - $15,000,000) × 10.1%]
EVA = $24,500,000 - $13,635,000
EVA = $10,865,000
C. Economic value added (EVA) measures the amount of shareholder wealth being created from a company's activities and operations. To expand, debt and equity capital are used to fund activities-activities that are hopefully conducted in a profitable manner. Profits cover the cost of the related capital, with shareholders benefiting from the residual (i.e., EVA).
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What will be an ideal response?