- 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
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
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%
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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