A risk-free investment of $5000 will retune 1.8%. A risky $5000 investment has a

Question

A risk-free investment of $5000 will retune 1.8%. A risky $5000 investment has a 9% chance of defaulting and returning only $1500. what is the expected rate of return on the risky investment? -4.7% 4.5% -35.9% -3.6% A risk-free investment of $5000 will return 1.8%. a risky $5000 investment has a 9% chance of defaulting and returning only $1500. how much must the risky investment promise to return? 8.1% 4.5% 7.2% 8.9% A risk-free investment of $5000 will return 3%. A risky $5000 investment has a 60% chance of defaulting and returning only $3000. What default premium must the risky investment offer? 30.0% 64.5% 40.5% 27.0% A new business opportunity has a 60% chance of being worth $500000 next year and a 40% chance of being worth $100000. The appropriate expected rate of return is 12%. Refer to the information above. This new opportunity will be financed with a $200000 commercial loan. What must the promised future payoff to the lender be? Round your answer to the nearest dollar. $303,571 $340,000 $395,294 $306,667 Refer to the information above. This new opportunity will be financed with a $200000 loan. What must the promised rate of return on the loan be? Round your answer to the nearest hundredth of a percent. 51.79% 97.65% 70.00% 53.33% Refer to the information above. The new opportunity will be financed with a $200000 bank loan. What is the expected future payoff for the levered equity holder? Round your answer to the nearest dollar. $116,000 $99,714 $79,5710 103,571

Explanation / Answer

9) Expected pay off of risky investment should be equal to risk free investment.

Risk Free = 5000*.018(Return) = 5090

Let Y be the exected return from risky investment.

If .09 is the probabiliy of default then .91 is the probability with which 5000*Y will be returned.

Risky = 5000*Y(Expected return from risky investment)*.91(Survival Probability)+.09*1500

to get the expected return on risky investment

5000*Y*.91+.09*1500 = 5090

Y = (5090-.09*1500)/(5000*.91)

Y = 8.9%

Expected rate if retrun of investor

=.5*1.8%+.5*8.9% as the investment is 50% in each assets

= 5.35%

10) D The risky investment promise to return 8.9%( Calculations from the above example)

11) B

To get the expected return on risky investment use the equation used in question number 9 but replace the risk free retrun with 3% and Probability of default with 60% and LGD to 3000

5000*Y*.4+.6*3000 = 5150

then Y = 67.50%

The risk premium expected is 67.50 - 3(Risk free rate) = 64.5%

12) A

Expected future cash flow is .6*500000+.4*100000 = 340000

Discounting it with 12% will give a PV of future cash flow of

303571.42

13) A

Assuming all the expected payoff will be allocated towards debt repayment

the retrun = ( 303571.42 - 200000)/200000

= 51.79%

14) C

Assuming thay 200000 is raised @ 12% rate of interest

224000 out of 303571.42 will be paid back and 79571.42 will be paid back to equity holders

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