The net new equity raised by a firm during a given year can be calculated as:
A. New equity sales minus equity repurchases plus retained earnings.
B. New equity sales minus dividends paid.
C. New equity sales minus equity repurchases plus retained earnings minus dividends paid.
D. New equity sales minus equity repurchases.
E. New equity sales plus retained earnings.
The Correct Answer and Explanation is :
The correct answer is A. New equity sales minus equity repurchases plus retained earnings.
Explanation:
Net new equity raised by a firm refers to the total amount of money the firm has generated through equity financing activities during a given period. This includes both external and internal sources of equity. To break this down:
- New equity sales: This represents the money raised by the firm from issuing new shares to investors. This can be done through public offerings, private placements, or other forms of equity issuance.
- Equity repurchases: This refers to the firm buying back its own shares from the market, which reduces the total amount of outstanding shares. Equity repurchases are considered a negative factor because they reduce the total equity available for the firm’s use.
- Retained earnings: Retained earnings are the portion of the company’s net income that is kept within the firm rather than being paid out as dividends. This is considered an internal source of equity that strengthens the firm’s financial position and increases its equity base.
The formula for calculating the net new equity raised by a firm is:
[
\text{Net new equity} = \text{New equity sales} – \text{Equity repurchases} + \text{Retained earnings}
]
The reason dividends are not part of this calculation is because dividends are distributions of earnings to shareholders, and do not directly raise new equity for the firm. In fact, paying dividends reduces the firm’s cash reserves, which is an outflow, but it does not affect the firm’s equity base in the same way that retained earnings do.
Thus, the net new equity raised considers the firm’s equity issuance (new equity sales), buybacks (equity repurchases), and the portion of profit reinvested back into the company (retained earnings). This formula accurately reflects the changes in the firm’s equity over a given period.
Let me generate an image to visually represent the formula.
Here is the diagram showing the formula for net new equity raised by a firm. It illustrates the components: new equity sales, equity repurchases, and retained earnings. Let me know if you’d like any more details!
