Question

Description.           project A.     project B
project cost.          1,000,000.     1,000,000
Debt/equity ratio   30/70.            80/20
project revenue.     100,000.       100,000
annual interest rate% 5                 7

Describe the significance of each of the parties to the project. ( investors, lenders etc). Describe the best to finance project based on return on equity and interpret your solution?

Answer 1

Significance of Investors and Lenders:

Investor:

• The investor invests money in the business with the expectation of minimizing risk and maximizing the return on investment.
• Investors are genuinely interest in the growth of the business and thereby the growth of its profits.
• Investors are paid a return on investment in the form of dividends, only if the business makes adequate profits.
• An investor is interested in the long run performance and profits of the company.

Lender:

• A lender is one who extends money in the form of loan to the business with the expectation of earning a fixed return on it.
• Lenders do not engage in the business and are only keen in obtaining the repayment of the loan money advanced along with an interest from the business.
• Lenders are paid a return on the loan amount advanced in the form of interest, irrespective of whether the company makes a profit or incurs a loss during the period.
• A lender is interested in engaging with the business only in the short run.

Return on Equity (ROE) = Net Income Available to Equity Holders / Shareholders Equity

Particulars	Project A	Project B
1. Total Project Cost	1,000,000	1,000,000
2. Debt @ 30% & 80%	300,000	800,000
3. Equity @ 70% & 20%	700,000	200,000
4. Annual Interest Rate	5%	7%
5. Project Revenue	100,000	100,000
6. Less: Interest on Debt (2*4)	15,000	56,000
7. Net Income Available to Equity (5-6)	85,000	44,000
8. ROE (7/3) * 100	12.14%	22%

Based on the Return on Equity, Project B is the best to finance, in case of an Investor.