A firm requires an investment of $20 000 and will return $25 000 after one year. If the firm borrows $10 000 at 7%, what is the return on levered equity?
A)43%
B)39%
C)29%
D)37%

Question

Quizplus · Accepted Answer

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

Return on Levered Equity = (Net Income - Interest Expense) / Equity Investment

First, we need to calculate the net income of the firm.
Net Income = Return on Investment - Interest Expense
Net Income = $25 000 - ($10 000 x 0.07)
Net Income = $18 300

Next, we can plug in the numbers into the formula for the return on levered equity:
Return on Levered Equity = ($18 300 - $7 000) / $20 000
Return on Levered Equity = $11 300 / $20 000
Return on Levered Equity = 0.565 or 56.5%

However, the answers given do not match the correct calculation. The closest option is A) 43%, which would be the correct answer if the interest expense was $5,000 instead of $7,000.

A Firm Requires an Investment of $20 000 and Will