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The Sustainable Growth Rate is equal to:

A)
(ROE) x (RR).
B)
(ROE) x (1+RR).
C)
(ROE) x (1-RR).



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).

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A high growth rate would be consistent with:

A)
a high ROE.
B)
a high dividend payout rate.
C)
a low retention rate.



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.

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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%.



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%

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If a firm’s growth rate is 12% and its dividend payout ratio is 30%, its current return on equity (ROE) is closest to:

A)

40.00%

B)

17.14%

C)

36.00%




g = (RR)(ROE)

g / RR = ROE

0.12 / (1 - 0.30) = 0.12 / 0.70 = 0.1714 or 17.14%

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A company with a return on equity (ROE) of 27%, required return on equity (ke) of 20%, and a dividend payout ratio of 40% has an implied sustainable growth rate closest to:

A)

12.00%

B)

10.80%

C)

16.20%




g = (RR)(ROE)

= (.60)(.27)

= 0.162 or 16.2%

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

A)
If the firm's payout ratio is 40%, has a required return of 12%, and a dividend growth rate of 7%, the firm's price to earnings (P/E) ratio should be 8.
B)
The liquidity risk of countries refers to the size and activity of the country's capital markets.
C)
ROA times one minus the dividend payout ratio is the firm's sustainable growth rate.



One minus the dividend payout ratio is the firm’s retention rate. The sustainable growth rate is the firm’s return on equity (ROE) times the retention rate.

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

A)
Accounting methods may differ substantially between countries.
B)
The business risk component of a country's risk premium is a function of the variability of economic activity in the country and the average operating leverage used by firms in the country.
C)
If the return on new investments is less than the return the firm is earning on its existing investments, the firm is considered a growth firm.



If the return on new investments is greater than the return the firm is earning on its existing investments, the firm is considered to be a growth firm.

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A company’s payout ratio is 0.45 and its expected return on equity (ROE) is 23%. What is the company’s implied growth rate in dividends?

A)

12.65%

B)

10.35%

C)

4.16%




Growth Rate = (ROE)(1 – Payout Ratio) = (0.23)(0.55) = 12.65%

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A company’s required return on equity is 15% and its dividend payout ratio is 55%. If its return on equity (ROE) is 17% and its beta is 1.40, then its sustainable growth rate is closest to:

A)

7.65%

B)

6.75%

C)

9.35%




Growth rate = (ROE)(Retention Ratio)

= (0.17)(0.45)

= 0.0765 or 7.65%

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Assuming a firm does not currently have excessive debt, a decrease in leverage will most likely cause the firm’s stock price to:

A)
decrease.
B)
remain the same.
C)
increase.



The firm’s stock price will most likely fall for two reasons: 1) loss of the debt tax shelter; 2) decrease in the leverage multiplier, A/E, causing ROE to decline.

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