CFA Level I · CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models
An analyst uses the DuPont decomposition of ROE. Net profit margin is 8%, total asset turnover is 1.25, and financial leverage (assets/equity) is 2.0. The company retains 55% of earnings. The sustainable growth rate is closest to:
The sustainable growth rate is about 11.0%. ROE from the DuPont components is 8% x 1.25 x 2.0 = 20%, and multiplying by the 55% retention ratio gives 11%. Reporting 20% would ignore that part of earnings is paid out.
- A8.0%
- B11.0%Correct
- C20.0%
Explanation
ROE = 0.08 x 1.25 x 2.0 = 20%. Sustainable growth = 0.55 x 20% = 11.0%. The 20% option is ROE itself, ignoring retention.
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