Which of the following statements is most correct?
A)If two companies have the same ROE and the same risk, they must have the same residual income (abnormal earnings) for the year.
B)If two companies have the same net book value and the same residual income this year, then their stock prices must be the same.
C)If two companies have the same ROE and the same stock price, their earnings must be the same for the year.
D)If two companies have the same ROE, net book value, and cost of capital, then their residual income must be the same for the year.

Question

Quizplus · Accepted Answer

Residual income is calculated as net income - (cost of capital x net book value). Therefore, if two companies have the same ROE and net book value, and their cost of capital is also the same, then their residual income would be the same. It is important to note that ROE is a measure of profitability, while residual income is a measure of economic value added. Stock price is influenced by multiple factors, including earnings, growth prospects, market conditions, and investor sentiment, among others. Therefore, statement B is not necessarily true. Statement A is also not necessarily true, as companies with the same ROE and risk may have different levels of assets and liabilities, leading to different amounts of residual income. Statement C is not necessarily true, as companies with the same ROE and stock price may have different levels of earnings, depending on their capital structure and financing costs.

Which of the Following Statements Is Most Correct