CFA Level I · CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models
A company has a constant ROE of 10% and currently retains 30% of earnings. Management wants to double its sustainable growth rate without changing ROE. The retention ratio required is closest to:
Management must retain about 60% of earnings. Current growth is 30% x 10% = 3%, so doubling to 6% with ROE fixed at 10% requires a retention ratio of 6% divided by 10%, or 60%.
- A40%
- B60%Correct
- C90%
Explanation
Current g = 0.30 x 10% = 3%. Target g = 6%. Required retention = 6%/10% = 60%. The 40% option adds ten points arbitrarily.
Did you get it right without looking?
One question tells you little. A timed set on Discounted Cash Flow (DCF) and Growth Models shows your real accuracy, how long you take and where you lose marks.
More Discounted Cash Flow (DCF) and Growth Models questions
- Holding return on equity constant and positive, a firm that raises its dividend payout ratio will most likely experience:
- An analyst values a mature, profitable utility that pays a stable dividend payout ratio and is expected to grow at a constant rate indefinit…
- An analyst estimates a stock's sustainable growth rate using a return on equity of 15% and a dividend payout ratio of 40%. The sustainable g…
- Compared with an FCFF valuation, an FCFE valuation is most likely to be preferred when the analyst is valuing a company that has:
- In a two-stage dividend discount model with a high-growth period of n years followed by constant growth, the terminal value at the end of ye…
- Holding all else constant, which change would most likely decrease the intrinsic value of a share estimated with the Gordon growth model?