7.1. If a firm takes steps that increase its expected future ROE (return on equi

Question

7.1. If a firm takes steps that increase its expected future ROE (return on equity), its stock price will _________ increase

a) never

b) not necessarily

c) always

7.2 Based on your understanding of the uses and limitations of ROE, which of the following projects should be chosen if they have the same risk and cost of capital?

a) Project X, with 35% ROE and a large investment, generating high expected cash flows

OR

b)Project Y, with 40% ROE and a small investment, generating low expected cash flows

7.3

Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company’s performance. If you wanted to conduct a trend analysis, you would:

a) Compare the firm’s financial ratios with other firms in the industry for a particular year

OR

b) Analyze the firm’s financial ratios over time

According to your understanding, a company with one key product is considered to be ___________ risky than companies with a wide range of products.

a) more

OR

b) less

Explanation / Answer

7.1) b) is correct as stock price depends of P/E ratio and a lot of other market fundamentals and the basic economic strong points of a stock. So high ROE not necessarily always increases the stock price.

7.2) I shall choose option a) . It is a project with high expected cash flow and higher chance that more funds will be available for fixed costs like interests and there will be better chance of higher surplus income for the equity share holders.

7.3) option b) is correct, i.e., Analyze the firm's financial ratios over time because in that way, we will be able to better accommodate our research about the company's roe by looking at its past performance.

7.4) option a) is correct, which means company with only one key product will be more risky than the company with a wide range of products because of dependence on the performance of the single product or lack of diversification in that company.

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