Equtiy Method

Schweser states that “Dividends received from the equity investment decrease the reported value of the investment (but increase cash).” Does this mean that as time goes on, the company’s stake in the company reduces as they receive dividends?

It means the dollar amount invested decreases… Suppose say your comapany made an investment of 100 in a company ABCD Inc by buying say 20 odd shares of the company (10% stake) Now at the yr end u recieve dividends of say 0.5 per share, so ur total divdend amounts to 10.... Hence your total cash investment in the company reduces to 100-10 = 90 and your cash and cash equivalents on the Balance sheet increases by 10$ BUT you still hold 20 shares of the company…your investment still worth $100(ignoring the effects of divdends recived on the stock price)… Hope this helps!

you would learn more of this in Level II. You as the equity investor would also get a proportion of the earnings of the company. so in the example above - if the company had earnings of say 50$ - your investment in subsidiary (equity account) would go up 10$ due to the income from the subsidiary, go down 10$ due to the dividends. Dividends are considered a RETURN on investment.

cpk123, can you please confirm my understanding?

the investment account would go up by the proportionate share of the income received from sub, and would be decreased by proportionate share of dividend received from sub. hope this explains. if the sub. has a +ve net income to declare - and usually since income of sub would be > than dividend of sub -> the investment account should go up. (not remain fixed at 100)

Therefore it isn’t the stake, as you mentioned, which is reduced, but the initial investment “outflow.” Could it be viewed similar to an NPV calculation where we take the initial -$100 investment and with the PV of the future cash flows, we could add them on and it would reduce the investment outflow, eventually giving us a positive NPV?