CFA® Level 1: CFA® Level 1

Which of the following statements is true?

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A. Given a small decrease in the real risk-free rate, a large increase in the risk premium for a stock, and a large decrease in the return on equity, one would expect the required rate of return on the stock to increase, the growth rate to decrease, and the earnings multiplier to increase.

B. Given a large decrease in the rate of inflation and the risk premium for a stock, and a large increase in the return on equity, one would expect the required rate of return on the stock to decrease, the growth rate to increase, and the earnings multiplier to increase.

C. Given a large increase in the rate of inflation, a small decrease in the risk premium for a stock, and a large decrease in the return on equity, one would expect the required rate of return on the stock to decrease, the growth rate to decrease, and the earnings multiplier to decrease.

D. Given a small increase in the rate of inflation, a small increase in risk premium for a stock, and a larger decrease in the return on equity, one would expect the required rate of return on the stock to increase, the growth rate to decrease, and the earnings multiplier to increase.

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A. B. C. D.

The direction of change approach to estimating an earnings multiplier begins with the current earnings multiplier and estimates the direction of change for the dividend payout ratio and the variables that influence the required rate of return and growth rate. The required rate of return is positively correlated with the real risk-free rate, the rate of inflation, and the risk premium. The growth rate is positively correlated with the return on equity and earnings retention rate. The earnings multiplier is positively correlated with the growth rate, and negatively correlated with the required rate of return.

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