CFA Practice Question

CFA Practice Question

Assume the following information for Bearstone Concrete and Manufacturing, Inc.

EPS: $6.25
ROE: 10.16%
Growth rate of dividends: 5.25%
Discount rate: 12.80%
Tax Rate: 35%
Common shares outstanding: 2,000,000

Using this information, what is the retention rate for this firm? Further, what is the annual dividend?
A. 48.33%; $3.02
B. 51.67%; $3.23
C. 51.67%; $3.02
Explanation: To determine the retention rate of dividends, the equation used to determine the growth rate of dividends must be manipulated. This equation is originally structured as follows: {g = ROE (1 - Dividend Payout Ratio)}.

In order to determine the retention rate, the equation must be rearranged to the following: {(1 - Dividend Payout Ratio) = Growth Rate of Dividends / ROE}.

Imputing the given information into this equation will yield: {(1 - Dividend Payout Ratio) = 0.0525/0.1016)} = 0.51673.

Remember that the retention rate is equal to (1 - Dividend Payout Ratio). Therefore, no further calculation is necessary to determine the retention rate.

In order to determine the annual dividend, take the Dividend Payout Ratio, which is found by (1 - Retention Rate), and multiply this figure by the Earnings Per Share calculation, which is given as $6.25. This will yield an annual dividend of $3.02.

As you can see, neither the discount rate, tax rate, nor the number of common shares outstanding is factored into the equation.

User Contributed Comments 5

User Comment
jackwez Easier way to remember/compute: 5.25 = 10.16 x RR... RR = 51.67% (1 - 51.67%) times 6.25 = $3.02.
Kuki How do we know that the Growth rate of dividends = Company Growth Rate? Do we assume that?
steved333 Yes. Growth rate means the same for the test's intents and purposes.

5.25/10.16 for g. Then (1-g)x6.25 for dividend.
indrayudha I suppose assuming dividend payout ratio remains the same, dividend growth can be seen as a proxy of earnings growth.
ashish100 jackwez showed the shortest way.

dividend = eps * div payout ratio

much faster than calculating total dividend / shares outs lol
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