Boylston Inc.'s total interest bearing debt is $10,000,000 on which it pays interest at the rate of 5%. Boylston's rate of return on assets is 10%. How much cash flow does leverage add to shareholders equity?

Question

Quizplus · Accepted Answer

We can calculate the cash flow added to shareholders equity by using the formula: (Rate of return on assets - Interest rate)*(Total interest bearing debt). 
In this case, the cash flow added is (10% - 5%)*$10,000,000 = $500,000. Since the question is asking for the cash flow added to shareholders equity, and a positive cash flow will increase shareholders equity, the correct answer is D, $500,000.