Total initial equity is $200,000 and annual before-tax cash flow to equity is $18,000. What current equity dividend rate results?
Correct Answer
B) 9.00%
18000÷200000×100 = 9. Common errors: inverting the ratio (equity ÷ cash flow) gives 1111.11%; misplacing the decimal (×1,000 instead of ×100) gives 90.00%; dividing by equity plus the cash flow gives 8.26%.
Why This Is the Correct Answer
Option B is correct because the equity dividend rate is $18,000 ÷ $200,000 = 0.09, and 0.09 × 100 = 9.00%. It measures annual cash flow to equity per dollar of initial equity.
Why the Other Options Are Wrong
Option A: 8.26%
Option A, 8.26%, divides by equity plus the cash flow: $18,000 ÷ ($200,000 + $18,000) × 100 = 8.26%. The denominator is initial equity alone, giving $18,000 ÷ $200,000 × 100 = 9.00%.
Option C: 90.00%
Option C, 90.00%, misplaces the decimal by multiplying by 1,000: $18,000 ÷ $200,000 × 1,000 = 90. The correct conversion is × 100, giving 9.00%.
Option D: 1111.11%
Option D, 1111.11%, inverts the ratio: $200,000 ÷ $18,000 × 100 = 1111.11%. Cash flow goes on top: $18,000 ÷ $200,000 × 100 = 9.00%.
Get over put
The dividend is what you get each year; equity is what you put in. Get over put, times 100.
How to use: Use this to set up any equity dividend rate calculation in the right direction.
Exam Tip
A cash flow under one tenth of the equity must give a rate under 10%; use that to rule out extreme answers quickly.
Common Mistakes to Avoid
- -Dividing equity by cash flow
- -Adding the cash flow to the equity in the denominator
- -Using the wrong factor to convert a decimal to a percentage
Concept Deep Dive
Analysis
This question tests the current equity dividend rate, which divides annual before-tax cash flow to equity by the initial equity. The skill is setting up the ratio in the right direction and converting it to a percentage with the right factor. The distractors invert the ratio, misplace the decimal or inflate the denominator.
Background Knowledge
The equity capitalization (dividend) rate equals annual pre-tax cash flow to equity divided by the equity investment. It is a one-year cash return measure. It differs from the equity yield rate, which considers the entire holding period including reversion.
Real-World Application
An appraiser surveying investors in a market for small retail buildings learns typical down payments and first-year cash flows after debt service. Dividing cash flow by down payment shows the equity dividend rates buyers are accepting.
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