Initial total equity is $150,000. Annual before-tax cash flow to equity after all property and financing outlays is $18,000. What current equity dividend rate results?
Correct Answer
B) 12.0%
18000÷150000×100 = 12. Common errors: inverting the ratio (equity ÷ cash flow) gives 833.3%; misplacing the decimal (×1,000 instead of ×100) gives 120.0%; dividing by equity plus the cash flow gives 10.7%.
Why This Is the Correct Answer
Option B is correct because $18,000 ÷ $150,000 = 0.12, or 12.0%. The equity dividend rate relates annual pre-tax cash flow to the equity invested. The cash flow is already after debt service, so no further adjustment is needed.
Why the Other Options Are Wrong
Option A: 10.7%
Option A, 10.7%, divides by equity plus the cash flow: $18,000 ÷ ($150,000 + $18,000). The denominator should be equity alone, giving 12.0%.
Option C: 120.0%
Option C, 120.0%, misplaces the decimal by multiplying by 1,000 instead of 100: $18,000 ÷ $150,000 × 1,000. The correct percentage is 0.12 × 100 = 12.0%.
Option D: 833.3%
Option D, 833.3%, inverts the ratio by dividing equity by cash flow: $150,000 ÷ $18,000. The rate puts cash flow on top, giving 12.0%.
After-debt cash over equity
Cash flow left after debt service goes on top; the equity invested goes underneath.
How to use: Use this to set up an equity dividend rate correctly.
Exam Tip
Check whether the stated cash flow is before or after debt service; here it is already after, so divide it directly by equity.
Common Mistakes to Avoid
- -Dividing equity by cash flow
- -Adding cash flow to the equity base
- -Using NOI instead of cash flow after debt service
Concept Deep Dive
Analysis
This question tests the equity dividend rate, annual before-tax cash flow to equity divided by total initial equity. The cash flow is already net of property and financing outlays, so it is divided directly by equity. The distractors invert, slip a decimal, or inflate the denominator.
Background Knowledge
The equity dividend rate is the first-year before-tax cash flow divided by the equity investment. It is used in the band of investment and in analyzing market investor expectations.
Real-World Application
An appraiser analyzing a recent sale confirms the buyer's down payment and expected first-year cash flow after mortgage payments. The ratio provides market evidence of equity dividend rates.
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