- CFA Exams
- CFA Level I Exam
- Study Session 13. Equity Investments (2)
- Reading 41. Equity Valuation: Concepts and Basic Tools
- Subject 2. Present Value Models: The Dividend Discount Model

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**CFA Practice Question**

An investor gathers the following data for a company:

Total assets: $200 million

Total liabilities: $120 million

Net income: $10 million

Dividends paid on common stock: $2 million

Net profit margin: 2%

Total assets: $200 million

Total liabilities: $120 million

Net income: $10 million

Dividends paid on common stock: $2 million

The company's estimated dividend growth rate (in %) is closest to ______.

A. 8.0

B. 10.0

C. 12.0

**Explanation:**ROE = Net income / Equity

Retention rate = 1 - (Dividends / Net income)

g = Retention rate x Return on equity

Equity = $200 million - $120 million = $80 million

ROE = $10 million / $80 million = 12.5%

Alternatively, using the DuPont model: ROE = Return on assets x Financial leverage or

Profit margin x Total assets turnover x Financial leverage

Sales = NI / NPM = $10 million / 0.02 = $500 million

TAT = 500 / 200 = 2.5

Financial leverage = 200 / 80 = 2.5

ROE = 2 x 2.5 x 2.5 = 12.5%

Retention rate = 1 - ($2 million / $10 million) = 80%

Growth rate = 12.5% x 80% = 10%

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