Use next year's Cash Flow Forecast for Blank Company to answer the following questions:

-Suppose Blank Company has only one project,as forecast above,and an unlevered cost of equity of 8%.If the company borrows $10,000 at 5% to make the investment,what is expected return to equity holders?

Question

Use next year's Cash Flow Forecast for Blank Company to answer the following questions:
 
-Suppose Blank Company has only one project,as forecast above,and an unlevered cost of equity of 8%.If the company borrows $10,000 at 5% to make the investment,what is expected return to equity holders?

Quizplus · Accepted Answer

To calculate the expected return to equity holders, we need to calculate the cost of equity which is given as 8% in the question.

Now, we need to calculate the levered equity return which can be found using the following formula:

Levered equity return = Unlevered equity return + (Unlevered equity return - Interest rate)*(Debt/Equity)

Unlevered equity return is the cost of equity which is 8%.
Interest rate is 5%.
Debt/Equity is (10,000 / 20,000) = 0.5 (from the balance sheet in the forecast).

Plugging in the values:

Levered equity return = 8% + (8% - 5%)*(0.5) = 9.33%

Therefore, the expected return to equity holders is 9.33%, which is closest to option C (9.33%).

Use Next Year's Cash Flow Forecast for Blank Company to Answer