CFA Level I · CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models
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 growth rate is closest to:
The sustainable growth rate is about 9%. It equals the retention rate times return on equity: (1 − 0.40) × 15% = 9%. Using the payout ratio instead of the retention rate would give 6%, which is incorrect.
- A6%
- B9%Correct
- C15%
Explanation
Retention = 1 − 0.40 = 0.60. g = retention × ROE = 0.60 × 0.15 = 9%. Using the payout ratio gives 6%, which is wrong because growth depends on retained earnings.
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