Equity investors have contributed $250,000 to your start-up business,while creditors provided a loan of $300,000.You have calculated your firm's WACC at 10%.The annual interest payment is $25,000 and the marginal corporate tax rate is 35%.How much profit will your equityholders need to earn in order to break even in economic terms (i.e.,EVA of zero)?

Question

Quizplus · Accepted Answer

To break even in economic terms (EVA of zero), the profit must cover both the cost of debt and the cost of equity. The after-tax cost of debt is $25,000 * (1 - 0.35) = $16,250. The cost of equity is $250,000 * 10% = $25,000. Therefore, the total profit needed is $16,250 + $25,000 = $41,250. However, the interest payment is already included in the profit calculation, so the equityholders need to earn $41,250 - $25,000 = $16,250. The closest option is $38,750, which accounts for the total profit needed before considering the interest payment.

Equity Investors Have Contributed $250,000 to Your Start-Up Business,while Creditors