Question

Bookmatch 8-14 (book/static) Question Help (Measuring growth) Given that a firm's return on equity is 18 percent and management plans to retain 40 percent of earnings for investment purposes, what will be the firm's growth rate? The firm's growth rate will be 96. (Round to two decimal places.)

Answer 1

Growth Rate = Return on Equity*Retention Ratio

= 18%*0.4

= 7.2%

Current value = (Expected Dividend+Market price)/(1+Required Return)

= (1.85+51.35)/(1.09)

= $48.81

Value = (1.85+42.50)/(1+0.11)

= $39.95

a.Price = Expected Dividend/(Required Return – Growth rate)

27.81 = 1.50(1+0.0840)/(Expected Return – 8.4%)

Expected Return = 14.25%

Value = 1.50(1+8.4%)/(10.4%-8.4%)

= $81.3

c.Yes, since rate is higher than expected

37.88 = 1.50(1+g)/(16%-g)

6.0608 – 37.88g = 1.50 + 1.50g

G = 11.58%

64.91 = 1.10(1+4%)/(Expected Return – 4%)

Return = 5.76%