- CFA Exams
- CFA Level I Exam
- Topic 4. Corporate Issuers
- Learning Module 16. Analysis of Dividends and Share Repurchases
- Subject 5. Payout policies
CFA Practice Question
A company had earnings of $3.00 last year and paid a regular dividend of $1.00. This year the company expects earnings of $4.00. Its target payout ratio is 50%, and it uses a 5-year period to adjust the dividend. What is the expected dividend for this year, based on Lintner's model?
B. $1.33
C. $2.
A.$1.1
B. $1.33
C. $2.
Correct Answer: A
According to Lintner, the stable dividend policy can be represented by a gradual adjustment process: The expected increase in dividends = increase in earnings x target payout ratio x adjustment factor
$1 + ($4 - $3) x 0.5 x 1/5 = $1.1.
User Contributed Comments 7
| User | Comment |
|---|---|
| charomano | Can anyone explain how the adjustment factor is calculated from the 5-year period? |
| fooshnip | Don't get bogged down by trying to remember some formula for the term "adjustment factor" - the concept is softening the volatility of dividends. You are simply recognizing the impact of the earnings volatility over 5 years in this case. Divide the earnings growth by 5, or multiply by .2. |
| REITboy | Since D1-D0 = Adjustment Rate x (E1 x Target Payout Ratio - D0) Why don't we get: D1-D0 = (1/5) x ($4 x 50% - $1) = $0.20 or D1 = $1.20? |
| fooshnip | My 2 cents is that I think it has to do with the earnings growth. you're making a gradual adjustment due to the earnings volatility. Your math, while correct, ignores the previous state of earnings. It implies that earnings would have jumped from 2$ to 4$ instead of the given 3$ to 4$. |
| Tlhogi | Adjustment factor= 1/number of periods(years) the adjustment will be made over |
| warnggg | Shouldn't this be $1.20? |
| Drangel01 | According to the book, the Expected increase in dividends = (Expected earnings × Target payout ratio – Previous dividend) × Adjustment factor For this reason the answer is 1.2 |