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Subject 5. Calculating an Implied Growth Rate in Residual Income PDF Download
Assuming the constant growth of residual earnings and constant ROE, we can calculate the growth rate, using this relationship: P / B = 1 + (ROE - r) / (r - g)

g = r - (ROE - r) / (P/B - 1)

Example

  • P/B ratio = 1.50.
  • Expected ROE = 12%.
  • Current book value per share = $9.00.
  • Cost of equity is 10%.

Current market price = 1.50 x $9.00 = $13.50.

Implied growth rate = 0.1 - (0.12 - 0.1) / (1.5 - 1) = 6%.

Learning Outcome Statements

calculate the implied growth rate in residual income, given the market price-to-book ratio and an estimate of the required rate of return on equity;

CFA® 2023 Level II Curriculum, Volume 4, Module 26

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