CFA Practice Question
An increase in the dividend payout ratio, a decrease in the required rate of return, and a slight increase in the growth rate would
A. have an unpredictable affect on the earnings multiplier.
B. increase the earnings multiplier.
C. decrease the earnings multiplier.
Explanation: The earnings multiplier is equal to Dp / (k - g), where Dp is the dividend payout ratio, k is the required rate of return, and g is the growth rate. The changes specified in this question would undoubtedly increase the earnings multiplier. This estimate is an example of the direction of change approach, which begins with the current earnings multiplier and estimates the direction and extent of change for the dividend payout ratio and the variables that influence the required rate of return and the growth rate of dividends and earnings.
User Contributed Comments 4
| User | Comment |
|---|---|
| dimanyc | If k goes down and g goes up there's a potential for k to become less than g, under which we will not be able to use this formula. That's why I chose A. I was waiting for it to be another trick question and it was not. :( |
| Janey | Just plug in your own numbers into the equation - easy to see what happens |
| Oarona | Janey: According to the question, A is definitely wrong. |
| ninad123 | if ROE>Cost of equity, increasing Dividend payout ratio will have a negative effect on the earnings multiplier, why this case is not considered? Any one? |