Chartered Financial Analyst (CFA) Level 1 Practice Exam

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Which formula is used to calculate dividend payment?

CFO / dividends paid
CFO / retained earnings
CFO / net dividends declared
CFO / total shareholder equity

The correct answer is: CFO / dividends paid

The formula that is most relevant to calculating dividend payments is centered around cash flow from operations (CFO) because it reflects the actual cash generated by the business that can be allocated for dividends. While option A suggests a relationship between CFO and dividends paid, it implies that a company’s ability to pay dividends is contingent on its operational cash flow, which is an essential factor, as dividends should ideally be covered by cash generated from business operations. Therefore, monitoring CFO is crucial in assessing the sustainability of dividend payments. The other options either misrepresent the relationships within financial statements or do not directly link to the concept of dividend calculation in a meaningful way. For example, retained earnings consider a cumulative total of earnings not distributed as dividends, which doesn't directly provide a formula for calculating dividends. Net dividends declared is similar but does not encompass the operational aspect that CFO provides. Lastly, total shareholder equity represents the owners' claim on assets after liabilities and does not provide a direct connection to cash flow or dividend payments. This underscores that CFO is the most indicative metric to evaluate the capacity to distribute dividends effectively.