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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%.

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