- CFA Exams
- CFA Level I Exam
- Study Session 11. Equity Valuation (3)
- Reading 30. Residual Income Valuation
- Subject 5. Calculating an implied growth rate in residual income

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**CFA Practice Question**

An analyst is estimating the implied growth rate of a company. She forecasts the company's ROE to be 25%. The trailing P/B ratio is currently 2.1. Using CAPM, she estimates the company's required rate of return on equity at 12%. The implied growth rate
should be:

A. 0.12%

B. 0.18%

C. 0.24%

**Explanation:**g = r - (ROE - r) / (P/B - 1) = 0.12 - (0.25 - 0.12) / (2.1 - 1) = 0.0018, or 0.18%.

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**User Contributed Comments**
6

User |
Comment |
---|---|

derektl2 |
is this one entirely wrong?? i mean... unless im going insane from too much studying.. 0.25-0.12 = 0.13 > 0.12 so the numerator is -0.01 while the denominator is 1.1 ... how is it possible there is a posititve number for growth?? |

SnowWhite |
It's right... g=r-[(ROE-r)/(P/B-1)] |

americade |
the key is to understand that (ROE-r]/(P/B-1) should be done first irrespective of r. then, subtract that from r. the math prob derek mentioned has to do with doing the numerator first then dividing by the denominator, that's incorrect, understandable mistake. |

volkovv |
this can also be solved as P/B = (ROE-g) / (r-g) just plug the numbers and solve for g |

jhmorris |
I'm with volkow on this one. Why remember another formula structure when you can just solve using a little algebra? |

birdperson |
I agree with @volkovv & @jhmorris |