CFA Practice Question

There are 151 practice questions for this study session.

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?

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
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