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 strong?
A) 8.0%
B) 8.95%
C) 28.6%
D) 38.0%

Question

Quizplus · Accepted Answer

B) In the strong demand scenario, cash flow is $45,000. Equity costs $31,666.67 initially ($45,000 / 1.08 - $10,000).
The firm must repay $10,500 ($10,000 × 1.05) to debt holders, so cash flow to equity is 11ea84dc_f50e_2de1_9a63_bb699146b531_TB1316_11_TB1316_11 . Expected return to equity is 11ea84dc_f50e_2de2_9a63_6108d65d6296_TB1316_11_TB1316_11 .

Suppose Blank Company Has Only One Project, as Forecast Above