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) 10.28%

Question

Quizplus · Accepted Answer

D) In the weak demand scenario, cash flow is $25,000. Equity costs $13,148.15 initially 11ea84dc_f50d_b8ae_9a63_29b49ad38f4b_TB1316_11_TB1316_11 .
The firm must repay $10,500 ($10,000 × 1.05) to debt holders, so cash flow to equity is 11ea84dc_f50d_dfbf_9a63_25b854cbd995_TB1316_11_TB1316_11 . Expected return to equity is 11ea84dc_f50d_dfc0_9a63_89f1960f229c_TB1316_11_TB1316_11 .

Suppose Blank Company Has Only One Project, as Forecast Above