A Firm Has a Return on Equity of 12

question 101

Multiple Choice

A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model.The market rate of return is 13.5 percent.What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC) ?

• A)12.4 percent because it is lower than 18.7 percent
• B)18.7 percent because it is higher than 12.4 percent
• C)The arithmetic average of 12.4 percent and 18.7 percent
• D)The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent
• E)13.5 percent

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Definitions:

Unincorporated Contractual Association

A group of individuals engaged in a business enterprise without forming a legal corporation.

Equity Method

An accounting technique used by a company to record its investment in another company when it has significant influence but not full control or majority ownership, typically involving the recognition of income proportional to its share of the investee's profits.

One-Line Method

A consolidation method where an investor reports its share of a subsidiary’s or associate’s single line item, such as net income, in its own financial statements.

Equity Method

An accounting technique used by a company to record its investment in another company when it has significant influence but does not have full control.