Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which of the following represents a profitability measure for shareholders?

1. Retention ratio

2. Dividend payout ratio

3. Return on Capital

4. FFO

The correct answer is: Return on Capital

Return on Capital is indeed a key profitability measure for shareholders. It assesses how effectively a company is using its capital to generate profits, providing insight into the efficiency of both equity and debt capital utilized in producing returns. This metric is important for shareholders as it indicates the potential for generating income from their investments relative to the capital employed in the business. The Retention ratio, while relevant for assessing a company's reinvestment strategy, focuses more on how much profit is retained for growth rather than the profitability itself. The Dividend payout ratio also informs about the portion of earnings distributed as dividends, but it does not directly measure profitability and can be influenced by many factors, including reinvestment needs or corporate policies. Fund from Operations (FFO) is predominantly used in real estate and focuses on cash generated from operations, but it is not a direct measure of profitability in the broader context of shareholder value. In summary, Return on Capital is a comprehensive measure that encapsulates profitability in the context of capital utilization, making it the most relevant option for assessing the profitability for shareholders.