CFA Practice Question

CFA Practice Question

If a company switches from straight line to accelerated depreciation method,
A. it lowers income but raises the ROE in the early years.
B. it lowers debt-equity as well as asset turnover ratios.
C. it increases the price-to-book value per share.
Explanation: Switching to accelerated depreciation lowers income and shareholders' equity compared to the straight line method. As a result, book value of equity goes down and price-to-book value multiple increases.

User Contributed Comments 6

User Comment
danlan What's wrong with A?
Carol1 Income decrease more in the nominator than the denominator Equity decrease, the result is the ROE is lower.
steved333 If RE is based on NI, then equity and income should be reduced equally. Of course, that still means that ROE is not higher, so A is still wrong...
mc42086 Not all income becomes equity. (Dividends, etc.)
01827 Depreciation has no effect on book value per share...

It would only reduce retained earnings not contributed capital....
GBolt93 BV isn't the amount paid for stock. BV is assets-liabilities (aka value of equity on the books equity). So if you decrease net assets as depreciation does, equity must also decrease in order for A=L+E to hold true. It would do so through decreased RE. Stock price wouldn't change since you haven't actually materially changed anything, just accounting methods, while BV would decrease because equity did. Therefore price-to-book would increase.
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