Mahoe Corporation has provided the following financial data: Dividends on common stock during Year 2 totaled $500. The market price of common stock at the end of Year 2 was $8.06 per share.The company's equity multiplier at the end of Year 2 is closest to:
A) 0.28
B) 1.28
C) 3.53
D) 0.78

Question

Mahoe Corporation has provided the following financial data:  Dividends on common stock during Year 2 totaled $500. The market price of common stock at the end of Year 2 was $8.06 per share.The company's equity multiplier at the end of Year 2 is closest to:
A) 0.28 
B) 1.28 
C) 3.53 
D) 0.78

Quizplus · Accepted Answer

To determine the equity multiplier, we need to first calculate the company's total assets at the end of Year 2. We can use the market price of common stock and the dividends paid to calculate the total number of outstanding common shares.

Total number of outstanding common shares = Dividends on common stock / Dividend per share
= $500 / ($8.06 − $0) = 61.99

Total market value of common equity = Total number of outstanding common shares × Market price per share
= 61.99 × $8.06 = $501.51

Total assets = Total market value of common equity / Common equity ratio

We do not have the common equity ratio to calculate total assets, but we can use the equity multiplier formula:

Equity multiplier = Total assets / Total common equity

Equity multiplier = (Total market value of common equity + Total debt) / Total common equity

The equity multiplier represents how much assets a company has for each dollar of common equity.

Assuming the company has no preferred stock or non-controlling interest, we can rearrange the formula:

Total debt = Equity multiplier × Total common equity − Total market value of common equity

We are given that dividends on common stock totaled $500 during Year 2. This is usually paid out of net income, which is equal to earnings available to common shareholders.

Earnings available to common shareholders = Dividends on common stock / Dividend payout ratio

Assuming a constant dividend payout ratio, we can calculate earnings available to common shareholders.

Earnings available to common shareholders = $500 / Dividend payout ratio

We do not have the dividend payout ratio to calculate earnings available to common shareholders, but we can use the following formula:

Earnings available to common shareholders = Net income − Preferred dividends

Since we are assuming that there is no preferred stock, we can simplify the formula:

Net income = Earnings available to common shareholders

We do not have net income, but we can use the following formula:

Net income = Return on equity × Average common equity

We do not have the return on equity, but we can use the following formula:

Return on equity = Net income / Average common equity

We do not have average common equity, but we can use the following formula:

Average common equity = (Beginning common equity + Ending common equity) / 2

We do not have the beginning common equity, but we can assume that it is equal to the ending common equity from the previous year.

Ending common equity for Year 1 is not given, so we cannot calculate average common equity. Therefore, we cannot calculate net income or earnings available to common shareholders.

Without this information, we cannot calculate the equity multiplier directly. However, we can use the fact that the equity multiplier represents how much assets a company has for each dollar of common equity to eliminate the choices that do not make sense.

Choice A (0.28): This implies that the company has only $0.28 of assets for each dollar of common equity, which is unlikely.

Choice C (3.53): This implies that the company has $3.53 of assets for each dollar of common equity, which is possible but unlikely given the market price of common stock at the end of Year 2.

Choice D (0.78): This implies that the company has only $0.78 of assets for each dollar of common equity, which is unlikely.

Choice B (1.28): This implies that the company has $1.28 of assets for each dollar of common equity, which is reasonable. Therefore, the best choice is B.

Mahoe Corporation Has Provided the Following Financial Data: Dividends