Suppose a firm's price/earnings ratio is 12.It has just paid a dividend of $2 per share to maintain a 40% payout ratio.What is the firm's return on equity if its price is $65?

Question

Quizplus · Accepted Answer

The formula to calculate the return on equity (ROE) is:
ROE = Net Income/Total Equity

However, we don't have the net income information. So, we need to use the dividend information to calculate the net income.

Dividend per share = Dividend Payout Ratio * Earnings per share
Dividend per share = 0.40 * Earnings per share
Earnings per share = Dividend per share / 0.40
Earnings per share = 2 / 0.40
Earnings per share = $5

Now, we can use the price/earnings ratio to calculate the earnings per share and then calculate the total equity.

Price/Earnings Ratio = Price per share / Earnings per share
12 = Price per share / 5
Price per share = $60

Total Equity = Price per share * Number of shares
Total Equity = $60 * 1 (assuming one share)
Total Equity = $60

Now that we have the net income and total equity we can calculate the ROE:

ROE = Net Income / Total Equity
ROE = $5 / $60
ROE = 0.0833 or 8.33%

However, we need to convert the decimal to a percentage:

ROE = 8.33 * 100%
ROE = 8.33%

Therefore, the answer is A) 13.89% (not listed as an option, so the closest answer is A) 8.33%).

Suppose a Firm's Price/earnings Ratio Is 12