Seeing is believing!
Before you order, simply sign up for a free user account and in seconds you'll be experiencing the best in CFA exam preparation.
Basic Question 4 of 7
In theory, a firm wanting to maximize share value should pay out as much of its earnings in dividends as possible if it believes that:
B. the company's future growth rate will be below its historical average.
C. the company will still have positive cash flow.
D. the company's future return on equity will be below its required rate of return.
A. investors are indifferent to the form of their return.
B. the company's future growth rate will be below its historical average.
C. the company will still have positive cash flow.
D. the company's future return on equity will be below its required rate of return.
User Contributed Comments 8
| User | Comment |
|---|---|
| setmefree | larger div payout is aimed to compensate for low ROE, hence lower capital gain? the firm is striking to balance, thus to max shareholder's return?? I dun get this question at all!! |
| setmefree | okay, lets try reverse engineering: P = D/(k-g)if expected ROE is low, g will be low, this effects share price negatively; to offset, div payout has to be large, which also increases g, this makes sure P increases. But how can you rule out answer B?!??? |
| stefdunk | because the growth rate may still be above market rate |
| katybo | if ROE < rr, you better return the capital to the shareholders via dividens so then can invest the money in a more profitable company. |
| haarlemmer | Let's try in this way. By paying out more dividend, the company has lower retained earnings, thus lower equity. It may be used to offset the lower expected ROE as equity part could be reduced. |
| Nightsurfer | Retaining the dividend puts it to an inefficient use. Investors can find a better use outside the firm. |
| cp24 | r = D/P +g ; g = ROE x retention rate For D, a lower ROE results in a lower g (assuming the retention rate does not change) so to compensate increase D; B is not correct. historical average has nothing to do with required rate of return. |
| davidt87 | cp24 you cant keep the retention rate unchanged if you increase the dividend payout. they are reciprocal. also i don't think the dividend discount model is the best way estimate the required rate of return and this question is meant to be conceptual. but in that equation increasing D does drive down r, so long P/B > 1.. Which makes sense because investors would be skittish if you were increasing your payout ratio when P/B is less than 1. |
I used your notes and passed ... highly recommended!
Lauren
Learning Outcome Statements
explain factors that affect dividend policy in practice;
calculate and interpret the effective tax rate on a given currency unit of corporate earnings under double taxation, dividend imputation, and split-rate tax systems;
CFA® 2025 Level II Curriculum, Volume 3, Module 16.