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Equity Income is recognized based on the net income of the investee company rather than from...

Equity Income is recognized based on the net income of the investee company rather than from dividends. While this approach may have theoretical merit, what potential problems might this cause for your evaluation of the cash-flow-generating ability of the investor?

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Equity income is recognised based on the retention of equity income rather than its payout as dividend. High retention ratio leads to low payout ratio which contributes to lower cash flow generating ability for the investor. High retained earning is beneficial to the company when return on equity is higher than required rate of return of investor and vice-versa. Hence equity income is recognised based on the net income of the investee company rather than from dividends.

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