Chartered Financial Analyst Level 2

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.