"Equity Investments":Return on equity

来源: 正保会计网校编辑：小鞠橘桔 2021/01/05 10:33:14　字体：大小

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Questions 1:

A group of analysts estimate a security’s mean expected value to be $98.00 with a standard deviation of $0.55. Using a confidence interval of plus or minus two standard deviations and given the security is trading at $97.50, the security appears to be:

A、 undervalued.

B、 fairy valued.

C、 overvalued.

Questions 2:

A company has initiated the process of selling unproductive land, representing 5% of its total assets, and using the proceeds to buy back its common shares. Holding other factors constant, these actions by the company will most likelyresult in a:

A、 lower sustainable growth.

B、 higher return on equity.

C、 higher operating margin.

View answer resolution

【Answer to question 1】B

【analysis】

B is correct. The confidence interval of the security is between $96.90 ($98 – 2 × $0.55) and $99.10 ($98 + 2 × $0.55). The security price of $97.50 is within the confidence interval so it is fairly valued.

A is incorrect. The confidence interval of the security is between $96.90 ($98 – 2 × $0.55) and $99.10 ($98 + 2 × $0.55). The security price of $97.50 is within the confidence interval so it is fairly valued.

C is incorrect. The confidence interval of the security is between $96.90 ($98 – 2 × $0.55) and $99.10 ($98 + 2 × $0.55). The security price of $97.50 is within the confidence interval so it is fairly valued.

【Answer to question 2】B

【analysis】

B is correct. Share buyback reduces equity, holding other factors (e.g., earnings) constant, thus return on equity will be higher.

C is incorrect. Selling unproductive land will not impact the operating profit and, holding sales constant, there would be no effect on operating margin.

A is incorrect. With higher ROE, holding the retention ratio constant, the sustainable growth would be higher, not lower.

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