Question

Your company has the debt to equity breakdown below. The cost of debt is 4% (based on the interest on debt of 5% and the tax rate of 20%) and the cost of the equity is 8%.     

	COST OF CAPITAL	PROPORTION OF TOTAL ASSETS
Equity	8%	.50
Debt	4% based on interest rate(1-t)	.50

A) What is your company’s Weighted Average Cost of Capital (WACC)?

B) Your company’s Recruiting Division has $920,000 in total assets, which is the total capital employed by this division. The Earnings Before Interest and Tax (EBIT) of the Recruiting Division is $177,000, and the tax rate is 20%. What is the Economic Value Added (EVA) for the Recruiting Division?






C) Is the Recruiting Division adding to the economic value of this company?

(Please see formulas below.)

Weighted average cost of capital =

WACC = [%Debt (Cost of Debt)] + [%Equity (Cost of Equity)]

OR

KW = (1-t)KDD + KEE
  D + E

Economic Value Added (EVA) = (After-tax Operating Profit) – (Cost of the Assets to make that profit)
EVA =   [(EBIT (1 – tax rate)] – [WACC (Capital employed)]

Answer 1