Question

A start-up chemical company has an average cost of capital of 15% per year. Additionally, it has a long-term goal of making at least a 20% per year rate of return on all investments; however, because of market opportunity the ROR can be reduced for the current project by 3%. If the company acquired $50 million in venture capital, how much did it have to earn in the first year

Answer 1

The start-up chemical company must earn $8.5 million in the first year.

What is Rate of Return (ROR)?

The rate of return (ROR) is the net gain of an investment for a period. The dollar ROR is computed by deducting interest on acquired funds (debts) from the earnings before interest.  It can be expressed as a percentage of the initial investment.

Data and Calculations:

Average cost of capital = 15%

Expected rate of return = 20%

Reduction in the rate of return = 3%

New expected rate of return (ROR) = 17% (20% - 3%)

Venture capital funds = $50 million

Interest expense on venture capital = $7.5 million ($50 million x 15%)

Earnings in the first year = $8.5 million ($50 million x 17%)

Thus, the start-up chemical company must earn $8.5 million in the first year.

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