Return On Equity: A Quiz

Assuming you want to earn a return of 10% and ignoring taxes, what multiple of earnings should you pay for the following business:

• return on equity equals 15%
• the business pays out 60% of its earnings as dividends, and reinvests the other 40%. You expect it to also earn 15% on the reinvested earnings?

I’ll even let you have multiple choice:

1. 14.5
2. 15.0
3. 15.9

Tomorrow, I’ll give the answer and explain why this little question is important.