A company with a return on equity of 15 percent and a plowback ratio of 60 percent would expect a constant growth rate of:
A)4 percent
B)9 percent
C)21 percent
D)25 percent

Question

Quizplus · Accepted Answer

Using the constant growth rate formula: 
ROE = (1 - Plowback ratio) x Required return on equity + Plowback ratio x Growth rate
15% = (1-0.60) x Required return on equity + 0.60 x Growth rate
15% = 0.40 x Required return on equity + 0.60 x Growth rate
Solving for the growth rate:
Growth rate = (15% - 0.40 x Required return on equity) / 0.60
Assuming a required return on equity of 10%, we get:
Growth rate = (15% - 0.40 x 10%) / 0.60 = 9%
Therefore, the company would expect a constant growth rate of 9 percent.

A Company with a Return on Equity of 15 Percent