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 60% equity and 40% debt.If the firm can borrow at 10%,what is the return on levered equity?

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Quizplus · Accepted Answer

The return on levered equity can be calculated using the formula: Return on Equity = [(Cash Flow - Debt Payment - Initial Equity Investment) / Initial Equity Investment] * 100%. Here, the debt portion is 40% of $20,000, which is $8,000, and the equity portion is 60% of $20,000, which is $12,000. The debt payment after one year, considering a 10% interest rate, is $8,000 * 10% = $800, making the total debt payment $8,800. The cash flow after one year is $25,000. Therefore, the return on equity is [(25,000 - 8,800 - 12,000) / 12,000] * 100% = 35%.

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