Question

Suppose you borrow $46794.93M when financing a gym with a cost of $92643.83M. You expect to generate a cash flow of $48289.49M at the end of the year if demand is weak, $88480.40M if demand is as expected and $114469.36M if demand is strong. Each scenario is equally likely. The current risk-free interest rate is 5.85% (risk of debt) and there's a 13.93% risk premium for the risk of the assets. What is the expected return of equity?

Answer 1

The expected return of equity is $107,413.07M.

Step-by-step explanation:

To calculate the expected return of equity, we need to calculate the weighted average return for each scenario and then multiply it by the probability of each scenario occurring. The formula for the expected return of equity is:

Expected Return of Equity = (Return in Weak Demand * Probability of Weak Demand) + (Return in Expected Demand * Probability of Expected Demand) + (Return in Strong Demand * Probability of Strong Demand)

Let's calculate the expected return of equity:

Expected Return of Equity = ($48,289.49M * 1/3) + ($88,480.40M * 1/3) + ($114,469.36M * 1/3)

Expected Return of Equity = $39,763.16M + $29,493.46M + $38,156.45M

Expected Return of Equity = $107,413.07M