Question

Suppose you borrow $54050.89M when financing a gym with a cost of $92099.30M. You expect to generate a cash flow of $49859.49M at the end of the year if demand is weak, $87551.79M if demand is as expected and $123863.40M if demand is strong. Each scenario is equally likely. The current risk-free interest rate is 4.18% (risk of debt) and there's a 13.27% risk premium for the risk of the assets. What would be the realized return of equity if the demand is weak?

Answer 1

The realized return on equity when the demand is weak is -4.79%.

Step-by-step explanation:

To calculate the realized return on equity when the demand is weak, we need to consider the cash flow generated and the cost of financing. In this case, if demand is weak, the cash flow is $49859.49M. The cost of financing is the risk-free interest rate plus the risk premium for the assets, which is 4.18% + 13.27% = 17.45%.

The realized return on equity is calculated by subtracting the cost of financing from the cash flow and dividing it by the amount borrowed. In this case, the borrowed amount is $54050.89M.

So, the realized return on equity when demand is weak would be: ($49859.49M - (17.45% * $54050.89M)) / $54050.89M = -0.0479 or -4.79%.