Question

5. A firm begins the year with a Book Value of $10 million. During the year it generates $5 million in net profits. It paid $1 million in interest on its bank loan. It decides to pay $3 million in dividends. What is its new Book Value at the start of next year?

a) $11 million

b) $12 million

c) $15 million

d) $16 million

Answer 1

The book value at the beginning of the year is $10 million. The net profits generated during the year is $5 million. Out of the net profit $3 million is paid as dividends to the shareholders. Thus, the firm has retained earnings of $2 million. (Net profit - Dividends paid)

Calculate the book value at the start of the next year as follows:

Book value at start of next year = Book value at the beginning of this year + Retained earnings

=$10 million + $2 million

=$12 million

Note: the amount of interest on the bank loan is already subtracted while calculating the net profits. Hence, it is not subtracted again.

Thus, the answer is option b) $12 million.