RobertA

Supergro has current dividends of $1, current earnings of $3, and a return on equity of 16%, what is its sustainable growth rate?

A) 12.2%.

B) 8.9%.

C) 10.7%.

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g = (1 – 1/3)(0.16) = 0.107

RobertA

Heather Callaway, CFA, is concerned about the accuracy of her valuation of Crimson Gate, a fast-growing telecommunications-equipment company that her firm rates as a top buy. Crimson currently trades at $134 per share, and Callaway has put together the following information about the stock:

Most recent dividend per share	$0.55
Growth rate, next 2 years	30%
Growth rate, after 2 years	12%
Trailing P/E	25.6
Financial leverage	3.4
Sales	$11.98 per share
Asset turnover	11.2
Estimated market rate of return	13.2%

Callaway’s employer, Bates Investments, likes to use a company’s sustainable growth rate as a key input to obtaining the required rate of return for the company’s stock.
Crimson’s sustainable growth rate is closest to:

A) 14.8%.

B) 13.2%.

C) 16.6%.

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Sustainable growth rate = ROE × retention rate
Earnings per share = price / (P/E) = $134 / 25.6 = $5.23
The retention rate represents the portion of earnings not paid out in dividends. = (5.23 − 0.55) / 5.23 = 0.89 or 89%
ROE = profit margin × asset turnover × financial leverage
ROE = 5.23 / 11.98 × 11.2 × 3.4 = 16.6%
Sustainable growth rate = 89% × 16.6% = 14.8%

RobertA

If a firm has a return on equity of 15%, a current dividend of $1.00, and a sustainable growth rate of 9%, what are the firm’s current earnings?

A) $2.50.

B) $1.50.

C) $1.75.

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The earnings can be determined by solving for earnings in the sustainable growth formula:
9% = [1 − ($1 / $Earnings)] × 0.15 or $1 / 0.4 = $Earnings = $2.50

RobertA

Which of the following is NOT a component of the sustainable growth rate formula using the DuPont model?

A) EBIT/interest expense.

B) Net income/sales.

C) Earnings retention ratio.

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SGR = b × ROE
where:
b = earnings retention rate = (1 − dividend payout rate)
ROE = return on equity
The SGR is important because it tells us how quickly a firm can grow with internally generated funds. A firm’s rate of growth is a function of both its earnings retention and its return on equity. ROE can be estimated with the DuPont formula, which presents the relationship between margin, sales, and leverage as determinants of ROE. In the 3-part version of the DuPont model: ROE = (NI/sales)(sales/assets)(assets/equity)

RobertA

Demonstrate the use of the DuPont analysis of return on equity in conjunction with the sustainable growth rate expression. The following statistics are selected from Kyle Star Partners (Kyle) financial statements:

Sales	$100 million
Net Income	$15 million
Dividends	$5 million
Total Assets	$150 million
Total Equity	$50 million

What is Kyle’s sustainable growth rate?

A) 24.5%.

B) 33.3%.

C) 20.0%.

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SGR	= ROE × [(net income − dividends) / net income]
	= (15 million / 50 million) × (15 million − 5 million) / 15 million
	= 20.0%

RobertA

Supergro has current dividends of $1, current earnings of $3, and a sustainable growth rate of 10%. What is Supergro’s return on equity?

A) 12%.

B) 15%.

C) 20%.

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The ROE for Supergro can be determined by solving for ROE in the sustainable growth formula:

ROE = 10% / [1 – ($1/$3)] = 15%

RobertA

If Cantel, Inc., has current earnings of $17, dividends of $3.50, and a sustainable growth rate of 11%, what is its return on equity (ROE)?

A) 13.85%.

B) 17.64%.

C) 11.91%.

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Cantel’s ROE is 13.85%:

ROE = 11% / [1 – ($3.50/$17.00)] = 13.85%

RobertA

In the five-part DuPont model ROE = (NI/EBT)(EBT/EBIT)(EBIT/sales)(sales/assets)(assets/equity), the product of the first three terms is:

A) net profit margin.

B) gross profit margin.

C) operating profit margin.

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(NI/EBT)(EBT/EBIT)(EBIT/sales) = (NI/sales) = net profit margin.

RobertA

Financial models such as the DDM represent a cornerstone of equity valuation from an academic standpoint. But in the real life, many analysts do not use the DDM. The least likely reason for this is:

A) some of the assumptions required are impractical.

B) the model lacks the flexibility required to model values in the real world.

C) modern research has shown that many of the old standbys do not work.

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The DDM requires assumptions that many analysts find impractical. In addition, the model lacks the flexibility to adapt to changing circumstances. Both of these problems can be overcome, to a large extent, by using spreadsheet modeling to forecast cash flows and other variables.

RobertA

Relative to traditional financial models like the dividend discount model, the biggest advantage of spreadsheet modeling is:

A) accuracy of computations.

B) simplicity of computations.

C) quantity of computations.

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Computations are no simpler or more complicated on a spreadsheet as opposed to a calculator. Accuracy tends to be improved with the use of a spreadsheet, because you don’t have to punch numbers into a calculator at any stage. However, someone truly concerned with accuracy can do a fine job with a calculator. The spreadsheet stands out when it comes to quantity. Analysts can program many permutations and scenarios into a spreadsheet, using minutes to do what would take hours or even days or weeks with a calculator.