A firm requires an investment of $20,000 and will return $26,500 after one year.If the firm borrows $5,000 at 7% what is the return on levered equity?
A)43%
B)39%
C)41%
D)45%

Question

Quizplus · Accepted Answer

The return on levered equity can be calculated using the formula:

Return on levered equity = (Return on assets - Interest rate on debt) x (1 - Tax rate)

Return on assets is given as (26,500/20,000) = 1.325 or 132.5%.

Interest on debt is given as (5,000 x 0.07) = $350.

Assuming a tax rate of 30%, we get:

Return on levered equity = (132.5% - 7%) x (1 - 30%) = 0.915 x 0.7 = 0.6415 or 64.15%.

Therefore, the answer is C) 41%.

A Firm Requires an Investment of $20,000 and Will Return