CFA Level I · CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models
Holding return on equity constant and positive, a firm that raises its dividend payout ratio will most likely experience:
A higher payout ratio most likely lowers the sustainable growth rate. Less of earnings is retained and reinvested, and with return on equity unchanged, growth equals retention times ROE, so it declines.
- Aa lower sustainable growth rateCorrect
- Ba higher sustainable growth rate
- Cno change in the sustainable growth rate
Explanation
Sustainable growth = b x ROE. A higher payout ratio lowers retention b, so with ROE fixed the growth rate falls. No change would occur only if ROE were zero.
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