Initial invested equity is $120,000 and annual before-tax cash flow to that equity is $15,000. What current equity dividend rate is annual cash flow ÷ equity?
Correct Answer
D) 12.5%
15000÷120000×100 = 12.5. Common errors: dividing by equity plus the cash flow gives 11.1%; inverting the ratio (equity ÷ cash flow = 8.0) and mislabeling that multiple as a percentage gives 8.0%; misplacing the decimal (×10 instead of ×100) gives 1.3%.
Why This Is the Correct Answer
Option D is correct because the equity dividend rate equals annual pre-tax cash flow to equity divided by the equity investment: $15,000 ÷ $120,000 = 0.125, and 0.125 × 100 = 12.5%.
Why the Other Options Are Wrong
Option A: 1.3%
Option A, 1.3%, results from misplacing the decimal: $15,000 ÷ $120,000 × 10 = 1.25, rounded to 1.3%. Converting to a percentage requires multiplying by 100, which gives 12.5%.
Option B: 8.0%
Option B, 8.0%, inverts the ratio: $120,000 ÷ $15,000 = 8.0, which is a multiple of cash flow, not a percentage rate. The equity dividend rate is $15,000 ÷ $120,000 × 100 = 12.5%.
Option C: 11.1%
Option C, 11.1%, divides by equity plus the cash flow: $15,000 ÷ ($120,000 + $15,000) × 100 ≈ 11.1%. The denominator should be the equity alone, giving $15,000 ÷ $120,000 × 100 = 12.5%.
Cash on cash
The equity dividend rate is often called the cash-on-cash return: cash received on top, cash invested on the bottom.
How to use: Use this phrase to remember which number goes in the numerator when an equity rate question appears.
Exam Tip
When a rate answer looks like a whole number such as 8.0, ask whether it is really a multiple from inverting the fraction.
Common Mistakes to Avoid
- -Dividing equity by cash flow and calling the multiple a percentage
- -Multiplying by 10 instead of 100 when converting to a percentage
- -Adding the cash flow to the equity in the denominator
Concept Deep Dive
Analysis
This question tests the equity dividend rate, also called the equity capitalization rate, which is annual before-tax cash flow divided by equity. Place the cash flow in the numerator and the equity investment in the denominator, then express the result as a percentage. $15,000 ÷ $120,000 = 0.125, or 12.5%.
Background Knowledge
The equity dividend rate measures the first-year before-tax cash return on the investor's equity, after debt service has been paid. It differs from the overall rate, which relates NOI to total property value. It is a single-year income rate, not a yield that accounts for future changes or resale.
Real-World Application
An investor puts $120,000 of equity into a small apartment building that produces $15,000 of cash flow after debt service. An appraiser comparing equity returns in the market computes a 12.5% equity dividend rate for this purchase.
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