Chartered Financial Analyst (CFA) Practice Exam Level 2

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How is the capitalization rate calculated?

  1. Market Price Per Share / Total Dividends

  2. Dividend Per Share / Current Market Price Per Share

  3. Current Market Price Per Share / Earnings Per Share

  4. Dividend Yield + Growth Rate

The correct answer is: Dividend Per Share / Current Market Price Per Share

The capitalization rate is a fundamental concept in finance that typically relates to the expected return on an investment, particularly in the context of valuing stocks and real estate. The correct method to calculate the capitalization rate involves taking the dividend per share and dividing it by the current market price per share. This approach effectively establishes the expected return an investor can anticipate from a stock based solely on its dividends. Specifically, the dividend per share reflects the portion of earnings distributed to shareholders, while the current market price per share indicates the investment's valuation in the market at a given time. By dividing the dividends by the market price, investors can gauge the yield they are receiving on their investment, which is central to understanding its capitalization rate. This calculation aligns well with the dividend discount model, further illustrating how market price and dividends interact to inform investors about the expected returns from their holdings.

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