You are given the following information about a firm: The growth rate equals 8 percent; return on assets (ROA) is 10 percent; the debt ratio is 20 percent; and the shares are selling at R36 each.What is the return on equity (ROE)?

Question

Quizplus · Accepted Answer

ROE = ROA x (1 - debt-to-equity ratio)
ROE = 10% x (1 - 0.20)
ROE = 8%

Since the firm's growth rate is 8%, we can calculate the dividend growth rate:
Dividend growth rate = ROE x (1 - dividend payout ratio)
Assuming the firm has a dividend payout ratio of 50%:
Dividend growth rate = 8% x (1 - 0.50)
Dividend growth rate = 4%

Using the dividend discount model, we can calculate the intrinsic value per share:
Intrinsic value per share = next year's dividend / (cost of equity - dividend growth rate)
Assuming the cost of equity is also 8%:
Intrinsic value per share = (R36 x 1.04) / (0.08 - 0.04)
Intrinsic value per share = R52.80

Since the shares are selling at R36 each, they are undervalued and it would be a good investment opportunity to buy them.

You Are Given the Following Information About a Firm: the Growth