honeycfa

The Sustainable Growth Rate is equal to:

A) (ROE) x (RR).

B) (ROE) x (1+RR).

C) (ROE) x (1-RR).

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The Sustainable Growth Rate is equal to the return on the equity portion of new investments (ROE) multiplied by the firm's retention rate (RR).

honeycfa

A high growth rate would be consistent with:

A) a high ROE.

B) a high dividend payout rate.

C) a low retention rate.

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Since g = retention rate * ROE, or (1 - payout ratio) * ROE, the only choice that would result in a higher g is a higher ROE. A low ROE, or a high dividend payout rate (which is the same as a low retention rate) would result in a low growth rate.

honeycfa

A firm has a profit margin of 10%, an asset turnover of 1.2, an equity multiplier of 1.3, and an earnings retention ratio of 0.5. What is the firm's internal growth rate?

A) 7.8%.

B) 6.7%.

C) 4.5%.

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ROE = (EAT / Sales)(Sales / Total Assets)(Total Assets)

ROE = (0.1)(1.2)(1.3) = 0.156

g = (retention ratio)(ROE) = 0.5(0.156) = 0.078 or 7.8%

honeycfa

Which of the following statements concerning security valuation is least accurate?

A) An investor may determine the required rate of return for the dividend discount model (DDM) by adding a risk premium to the nominal risk-free rate.

B) An investor can estimate the growth rate for the dividend discount model (DDM) by multiplying the firm's return on equity (ROE) by the firm's dividend payout ratio.

C) Business risk is a component of a country's risk premium.

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An investor can estimate the growth rate for the DDM by multiplying the firm’s ROE by the retention rate, which is one minus the firm’s dividend payout ratio.

honeycfa

Given the following information, compute the implied dividend growth rate.

• Profit margin = 10.0%
• Total asset turnover = 2.0 times
• Financial leverage = 1.5 times
• Dividend payout ratio = 40.0%

A) 18.0%.

B) 4.5%.

C) 12.0%.

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Retention ratio equals 1 – 0.40, or 0.60.
Return on equity equals (10.0%)(2.0)(1.5) = 30.0%.
Dividend growth rate equals (0.60)(30.0%) = 18.0%.

honeycfa

If the return on equity for a firm is 15% and the retention rate is 40%, the firm’s sustainable growth rate is closest to:

A) 6%.

B) 15%.

C) 9%.

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g = (RR)(ROE)

= (0.15)(0.40)

= 0.06 or 6%

honeycfa

Which of the following statements concerning security valuation is least accurate?

A) The top-down approach to security valuation starts with an examination of the economy of each country.

B) A common stock with no growth in the dividend is valued like preferred stock.

C) The retention rate in the dividend discount model is one minus the growth rate.

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The retention rate is one minus the dividend payout ratio.

honeycfa

All else equal, the price-to-earnings (P/E) ratio of a stable firm will increase if the:

A) ROE is increased.

B) dividend payout is decreased.

C) long-term growth rate is decreased.

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The increase in growth rate will increase the P/E ratio of a stable firm and growth rate can be calculated by the formula g = ROE * retention ratio. All else being equal an increase in ROE will therefore increase the P/E ratio. Note that decreasing the dividend payout ratio and decreasing the long term growth rate will both serve to decrease the P/E ratio.

honeycfa

Which of the following is NOT an assumption of the constant growth dividend discount model (DDM)?

A) The growth rate of the firm is higher than the overall growth rate of the economy.

B) Dividend payout is constant.

C) ROE is constant.

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Other assumptions of the DDM are: dividends grow at a constant rate and the growth rate continues for an infinite period.

honeycfa

REM Corp.’s return on equity (ROE) is 19.5% and its dividend payout rate is 45%. What is the company’s implied dividend growth rate?

A) 19.5%.

B) 10.73%.

C) 8.78%.

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g = (ROE)(RR)

g = (19.5)(1 - 0.45)

g = (0.195)(0.55)

= 0.1073 or 10.73%