Tax Rate and Earnings Multiple of a Stock Market Series

The Effect of Tax Rate Increase on Earnings Multiple

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Question

An increase in the tax rate, while holding everything else equal, would have what effect on the earnings multiple of a stock market series? Further, what effect should be anticipated from an increase in the depreciation per-share figure?

Answers

A. Earnings multiple would increase, earnings multiple would increase.

B. Earnings multiple would increase, earnings multiple would increase.

C. Earnings multiple would remain unchanged, earnings multiple would decrease.

D. Earnings multiple would decrease, earnings multiple would decrease.

E. Earnings multiple would decrease, earnings multiple would remain unchanged.

F. Earnings multiple would increase, earnings multiple would remain unchanged.

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Explanations

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A. B. C. D. E. F.

The following equation is used to determine the earnings multiple of a stock market series:

EPS = {[(Sales per share * operating profit margin) - depreciation per share - interest expense per share] * (1 - corporate tax rate).

As you can see, an increase in the tax rate, holding everything else equal, will lead to a decrease in the earnings multiple. Likewise, an increase in the per-share depreciation figure will lead to a decrease in the earnings multiplier.

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