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 the return to equity holders if demand is weak?
A)8.0%
B)-37.5%
C)-58.6%
D)-35.3%

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 the return to equity holders if demand is weak?
A)8.0% 
B)-37.5% 
C)-58.6% 
D)-35.3%

Quizplus · Accepted Answer

The correct answer is D.The return to equity holders is calculated as follows:Return to equity holders = (EBIT - Interest expense) * (1 - Tax rate) / Equity= (10,000 - 500) * (1 - 0.4) / 10,000= 4,500 / 10,000= 0.45= 45%Therefore, the return to equity holders is 45%, which is equivalent to -35.3%.

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