- CFA Exams
- CFA Level I Exam
- Topic 5. Equity Valuation
- Learning Module 26. Residual Income Valuation
- Subject 6. Multistage Residual Income Valuation

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**CFA Practice Question**

Consider the following information:

- ROE = 12%.
- Required rate of return on equity = 10%.
- Dividend payout ratio = 60%. The company's justified P/B, using the residual income model and a constant growth rate assumption, is ______.

A. 1.56

B. 1.38

C. 1.30

**Explanation:**g = b x ROE = (1 - 0.60) x 0.12 = 0.048.

P

_{0}/B

_{0}= (ROE - g) / (r - g) = (0.12 - 0.048) / (0.1 - 0.048) = 1.38.

or P

_{0}/B

_{0}= 1 + (ROE - r) / (r - g) = 1 + (0.12 - 0.1)/(0.1 - 0.048) = 1.38.

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**User Contributed Comments**
1

User |
Comment |
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jsp2012 |
Or P/B = (ROE * Payout rate) / (r - g) |