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CFA Level I · CFA Level I Exam · Sources of Equity Returns

A firm that moves from paying out most earnings as dividends to retaining and reinvesting them in profitable projects would most likely shift its shareholders' expected return toward:

The shift most likely produces higher expected capital gains and a lower dividend yield. Paying out less reduces current income, while retained earnings invested in profitable projects raise growth and expected price appreciation.

  1. Alower capital gains and a higher dividend yield
  2. Ba higher dividend yield and unchanged capital gains
  3. Chigher expected capital gains and a lower dividend yieldCorrect

Explanation

Lower payouts reduce the dividend yield. Profitable reinvestment raises future earnings and growth, which should show up as larger expected price appreciation. The other choices reverse or ignore this trade-off.

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