P/E Ratio Calculation | CFA® Level 1 Exam Prep

Calculate Earnings Retention Ratio

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Question

A stock's P/E ratio is 6.4, with an expected return of 8% and a dividend growth rate of 4%. The firm's earnings retention ratio equals ________.

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A. B. C. D.

Explanation

In standard notation, the Dividend Discount Model gives P/E = (dividend payout ratio)/(K - g). Therefore, dividend payout ratio = 6.4*(8% - 4%) = 25.6%. The earnings retention ratio equals 1 minus the dividend payout ratio. In this case, the earnings retention ratio equals 1 - 25.6% = 74.4%.

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