Calculating Weighted Average Cost of Capital and Economic Value Added (EVA)
Ignacio, Inc., had after-tax operating income last year of $1,197,000. Three sources of financing were used by the company: $2 million of mortgage bonds paying 4 percent interest, $5 million of unsecured bonds paying 6 percent interest, and $9 million in common stock, which was considered to be relatively risky (with a risk premium of 8 percent). The rate on long-term treasuries is 3 percent. Ignacio, Inc., pays a marginal tax rate of 30 percent.
1.
Calculate economic value added (EVA) for Ignacio, Inc., for last year. If the EVA is negative, enter your answer as a negative amount.
$ fill in the blank
Is the company creating or destroying wealth?
2.
What if
Ignacio, Inc., had common stock which was less risky than other stocks and commanded a risk premium of 5 percent? How would that affect the weighted average cost of capital?
What is the new EVA? In your calculations, round weighted average percentage cost of capital to four decimal places. If the EVA is negative, enter your answer as a negative amount.
$ fill in the blank