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Basic Question 5 of 5
Clay Corporation earns a rate of return on common stockholders' equity of 14%. Which of the following will cause the rate of return to increase?
B. Increasing the size of the cash dividend paid on common stock
C. An increase in the company's price-earnings ratio
D. An increase in the market price of the company's stock
A. Issuing 9% bonds and investing the proceeds to earn 12%
B. Increasing the size of the cash dividend paid on common stock
C. An increase in the company's price-earnings ratio
D. An increase in the market price of the company's stock
User Contributed Comments 12
| User | Comment |
|---|---|
| quincy | why? |
| gopherz1 | increased leverage |
| robbjm30 | the funds earn 12% but the interest is only 9% and so the profits are increased relative to equity even with higher interest expense |
| myanmar | leverage effect |
| Shelton | ROCE = (EBIT/Assets - Int/Assets) * (Assets/Equity) * (1-t) - Pref.Div./Equity |
| thekapila | Lets see every choice. B. Increasing the size of the cash dividend paid on common stock. Its just moving money from income to equity .so no effect. C. An increase in the company's price-earnings ratio. SO it might be lowering earnings so increasing the ratio.Which might lower ROE. D. An increase in the market price of the company's stock. it doesn't affect ROE. |
| chisenga | This is nothing but "Du Pont". Answer C and D seems to only increase P/E. Answer B will likely decrease equity, we are left with A which in effect is a piece in the Du Pont formular. |
| alai2008 | if investing all the money in the company supposed an earning of 14% and investing part of the money in financial markets is 12% the result must lower the previous 14% |
| Sean12211 | Bonds are not equity, they are debt. Therefore net income increases and equity remains the same. |
| aravinda | I think simply put, adding debt to the capital structure causes equity to become more risky.. becaue, if the company went bankrupt, they will have to pay the bond holders first and then if there is any money is left then the equity holders will get a proportionate allotment (I think I am right). So due to the added risk for the equity holders, the return on equity must increase. |
| davcer | excess spread that generates financial income thus increasing a higher net income |
| ascruggs92 | I chose B. because a higher cash dividend on common stock would reduce Retained Earning faster, in turn reducing the company's equity. ROE = NI/E, so less equity means a higher return without a change to NI. A. is right though. Debt & Assets increase, leaving equity the same, and because the ROI is 12% while the cost is 9%, it will be accretive to earnings. Higher NI with no change in equity means a higher ROE |
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Learning Outcome Statements
explain the role of equity securities in the financing of a company's assets
contrast the market value and book value of equity securities
compare a company's cost of equity, its (accounting) return on equity, and investors' required rates of return
CFA® 2024 Level I Curriculum, Volume 3, Module 4.