Question

A new business opportunity has a 85% chance of being worth $750000 next year and a 15% chance of being worth $150000. The appropriate expected rate of return is 11%.     This new opportunity will be financed with a $540000 loan. What must the promised rate of return on the loan be? Round your answer to the nearest hundredth of a percent.

Answer 1

A new business opportunity has an 85% chance of being worth $750000 next year and a 15% chance of being worth $150000, thus the expected worth of business opportunity is:

=(Prob.1 * Value 1) + (Prob.2 * Value 2)

=(0.85*750000) + (0.15*150000)

=$660,000

The expected rate of return is 11% on the expected worth of opportunity, thus expected the return on the business opportunity in $ is:

= Expected worth of business opportunity * Expected rate of return

=$660,000 * 11%

=$72,600

Loan amount is $ 540,000, expected return on business is $ 72,600, hence the promised rate of return must equal to:

=Expected return on business / Loan amount

=72600/540000

=13.445%