A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm can borrow at 7%,what is the return on levered equity?

Question

Quizplus · Accepted Answer

The return on levered equity can be calculated using the formula: Return on Equity = [(Cash Flow - Investment - Interest) / Equity]. Here, the cash flow is $25,000, the investment is $20,000, and the debt portion is 50% of $20,000, which is $10,000. The interest on the debt at 7% is $700 ($10,000 * 7%). The equity portion is also $10,000 (50% of $20,000). Plugging these numbers into the formula gives: [(25,000 - 20,000 - 700) / 10,000] = 4,300 / 10,000 = 43%.

A New Business Requires a $20,000 Investment Today,and Will Generate