Increase in a Firm's ROE

C

An increase in a firm's return on equity (ROE) will increase its expected growth rate of earnings and dividends. This, in turn, will increase the earnings multiplier.

An increase in a firm's Return on Equity (ROE) will generally have an effect on the firm's expected growth rate and the earnings multiplier. Let's go through each answer choice to determine the correct one:

A. Have no effect on the firm's expected growth rate. This answer is incorrect. ROE is a measure of a company's profitability and efficiency in generating returns for its shareholders. A higher ROE generally indicates that the company is using its assets more effectively to generate profits. This improved profitability can contribute to higher expected growth rates for the firm.

B. Decrease the earnings multiplier. This answer is incorrect. The earnings multiplier, also known as the price-to-earnings (P/E) ratio, is a valuation metric that reflects the market's expectation for a company's future earnings growth. A higher ROE is often perceived positively by the market, leading to increased investor confidence and potentially a higher P/E ratio. Therefore, an increase in ROE is more likely to increase the earnings multiplier, not decrease it.

C. Increase the earnings multiplier. This answer is correct. As mentioned earlier, a higher ROE is generally viewed favorably by investors as it indicates the company's ability to generate higher profits relative to its shareholders' equity. Investors may be willing to pay a higher multiple of earnings (earnings multiplier) for a company with a strong ROE, expecting continued growth and profitability. Therefore, an increase in ROE is likely to increase the earnings multiplier.

D. Decrease the firm's expected growth rate. This answer is incorrect. As stated earlier, a higher ROE typically indicates that the company is generating higher profits relative to its equity. This improved profitability can support the firm's growth prospects. A higher ROE allows a company to reinvest its earnings and generate higher returns, potentially leading to an increased expected growth rate. Therefore, an increase in ROE is more likely to increase the firm's expected growth rate, not decrease it.

In summary, the correct answer is: C. Increase the earnings multiplier.