Chartered Financial Analyst Level 2
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- An analyst gathers the following information about a company with a stable dividend policy:
- Previous year's EPS:
$2.00 - Previous year's payout ratio: 30%
- Current year's expected EPS:
$2.50 - Target payout ratio: 36%
If the company uses a 3-year period to adjust its dividends, the expected increase in the current year dividend per share should be:
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A
$0.10
B
$0.20
C
$0.30
Explanation:
Explanation
This question involves the Lintner model of dividend policy, which states that companies adjust dividends gradually toward a target payout ratio over time.
Given Information:
- Previous year EPS =
$2.00 - Previous year payout ratio = 30%
- Previous year DPS =
$2.00× 30% =$0.60 - Current year expected EPS =
$2.50 - Target payout ratio = 36%
- Adjustment period = 3 years
Calculation:
Step 1: Calculate the target dividend per share (DPS)
Target DPS = Current year EPS × Target payout ratio
= $2.50 × 36% = $0.90
Step 2: Calculate the adjustment factor Since the company uses a 3-year adjustment period, the adjustment factor = 1/3 = 0.3333
Step 3: Apply the Lintner model formula Expected DPS = Previous DPS + Adjustment factor × (Target DPS - Previous DPS)
Expected DPS = $0.60 + (1/3) × ($0.90 - $0.60)
= $0.60 + (1/3) × $0.30
= $0.60 + $0.10
= $0.70
Step 4: Calculate the expected increase
Expected increase = Expected DPS - Previous DPS
= $0.70 - $0.60 = $0.10
Therefore, the expected increase in the current year dividend per share is $0.10, which corresponds to Option A.
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