Explain how ROE, ROA and P/E a

Explain how ROE, ROA and P/E are affected when new common stockis issued by a corporation? Identify two different factors thataffect stock price besides issuing new shares or repurchasingshares and how the price is affected?

Answer:

ROE:-  If a company issues common shares during aparticular period, the average equity would increase. This wouldmean a lower ROE, assuming that the net income stays the same.

ROA:- If a company issues common shares during a particularperiod, the average asset would increase due to increase in thecash inflow from issuance of new shares. This would mean a lowerROA, assuming that the net income stays the same.

P/E:- If a company issues common shares during a particularperiod, price and earnings per share, both of them would decrease.This is because an increase in the number of shares will decreasethe earnings per share, which in turn will decrease the price ofthe share , causing a decline in P/e ratio. But if the new issuanceis used to decrease the debt of the company, it will have positiveeffect on the share price because of the decrease in the risk ofinterest payment. This eventually leads to increase in p/e ratio .Therefore, the effect on p/e ratio due to new issuance depends onthe motive for which it is issued and circumstances of the company.Hence we cannot determine the effect of new issuance on p/e ratio.But in general, p/e ratio increases with new issuance.

Factors affecting stock price

A) Interest rates:- In case of lower interest rates, demand forfunds is higher and the subsequent demand for shares rises.Thisleads to increase in the price of the share .On the other hand,high interest lowers the demand for funds and the demand for sharesis lower leading to decrease in share price.

B) Dividend:- Dividends indicate the movement of share prices.When companies make dividend announcements, the share prices ofsuch companies are likely to increase. It is important to note thatif the dividend rate announced is lower than the investors’expectations, share prices decline while if they are up to morethan expected, share prices increase.


 
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