- CFA Exams
- CFA Level I Exam
- Topic 5. Equity Investments
- Learning Module 41. Equity Valuation: Concepts and Basic Tools
- Subject 3. Present Value Models: The Dividend Discount Model

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**CFA Practice Question**

Data that helps to compute expected growth rates of companies are furnished below:

Dividend payout ratio | 37.5% | 40.0%

Return on assets | 12% | 10.0%

Financial leverage | 1.6 | 2.0

Item | Company 1 | | Company 2

Dividend payout ratio | 37.5% | 40.0%

Return on assets | 12% | 10.0%

Financial leverage | 1.6 | 2.0

Which of the following best describes the expected growth rate of Company 1? The expected growth rate of Company 1 compared to Company 2 is ______.

A. lower

B. the same

C. higher

**Explanation:**ROE = Return on assets x Financial leverage

Retention rate = 1 - (Payout ratio);

g = Retention rate x Return on equity

Company 1: ROE = 12% x 1.6 = 19.2%; g = (1 - 0.375) x 19.2 = 12%

Company 2: ROE = 10% x 2.0 = 20.0%; g = (1 - 0.400) x 20.0 = 12%

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