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Copy of Estimating Growth Rates (Teaching Model)

# Copy of Estimating Growth Rates (Teaching Model)

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03/18/2014

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Kurt Hess, kurthess@waikato.ac.nz
Page 1
Estimating Determining Growth Rates.xls
Estimating Growth Rate Formulas
Teaching model prepared by Kurt Hess, University of Waikato Management School
ROA
6.0%
60
Return on Assets = Net Income / Total Assets
Payout
25.0%
250
Dividend Payout Ratio
D/(D+E)
75.0%
750
Leverage (L)
D/E
3.00
Gearing = L/(1-L)
i
10.0%
100
Interest rate
t
33.0%
330
Tax rate
ROE
3.90% = ROA + D/E*(ROA- i*(1-t))
Growth Unlevered Firm
4.50% = (1 - Payout) * ROA
Growth Levered Firm
2.93% = (1 - Payout) * ROE
2.93%
gU
gL
gL
direct formula: (1+D/E)*gU - {D/E*(1-Payout)*i*(1-t)}
Derive Relationship between ROE and ROA
ROA\ue000D
E\ue000ROA\u2212i\ue0001\u2212t\ue001\ue001=NI\ue000Int\ue0001\u2212t\ue001
\ue000D\ue000E \ue001
\ue000D
E\ue000NI\ue000Int\ue0001\u2212t\ue001
\ue000D\ue000E \ue001
\u2212Int\ue0001\u2212t\ue001
D
\ue001
ROA\ue000D
E\ue000ROA\u2212i\ue0001\u2212t\ue001 \ue001=\ue000NI\ue000Int\ue0001\u2212t\ue001
\ue000D\ue000E \ue001\ue001\u00d7\ue0001\ue000D
E\ue001\u2212Int\ue0001\u2212t\ue001
E
ROA\ue000D
E\ue000ROA\u2212i\ue0001\u2212t\ue001 \ue001=\ue000NI
\ue000D\ue000E \ue001\ue000Int\ue0001\u2212t\ue001
\ue000D\ue000 E \ue001\ue000D\u00d7NI
E\u00d7\ue000 D\ue000E\ue001\ue000D\u00d7Int\ue0001\u2212t\ue001
E\u00d7\ue000 D\ue000E\ue001\ue001\u2212Int\ue0001\u2212t\ue001
E
ROA\ue000D
E\ue000ROA\u2212i\ue0001\u2212t\ue001 \ue001=\ue000E\u00d7NI
E\u00d7\ue000 D\ue000E\ue001\ue000E\u00d7Int\ue0001\u2212t\ue001
E\u00d7\ue000 D\ue000E\ue001\ue000D\u00d7NI
E\u00d7\ue000 D\ue000E\ue001\ue000D\u00d7 Int\ue0001\u2212t\ue001
E\u00d7\ue000 D\ue000E\ue001\ue001\u2212Int\ue0001\u2212t\ue001
E
( )
(
)
(
)
( )
(
)
(
)
( )
(
)
( )
E
t
Int
E
D
E
t
Int
D
E
D
E
NI
D
E
D
E
t
Int
E
E
D
E
NI
E
t
i
ROA
E
D
ROA
\u2212
\u2212
\ue004\ue004\ue005\ue003
\ue001\ue001\ue002\ue000
+
\u00d7
\u2212
\u00d7
+
+
\u00d7
\u00d7
+
+
\u00d7
\u2212
\u00d7
+
+
\u00d7
\u00d7
=
\u2212
\u2212
+
1
1
1
1
ROA\ue000D
E\ue000ROA\u2212i\ue0001\u2212t\ue001 \ue001=\ue000\ue000NI\ue000Int\ue0001\u2212t\ue001 \ue001\u00d7\ue000D\ue000E\ue001
E\u00d7\ue000 D\ue000E\ue001
\ue001\u2212Int\ue0001\u2212t\ue001
D
=NI
E
\ue000Int\ue0001\u2212t\ue001
E
\u2212Int\ue0001\u2212t\ue001
E
ROA\ue000D
E\ue000ROA\u2212i\ue0001\u2212t\ue001\ue001=NI
E
=ROE
Derive Growth Rate of Levered (gL) and Unlevered (gL) Firm
gL=\ue0001\u2212 payout\ue001\u00d7ROE
gU=\ue0001\u2212 payout\ue001\u00d7ROA
(see Corporate Finance textbook on how to derive this)
gL=\ue0001\u2212 payout\ue001\u00d7\ue000 ROA\ue000D
E\ue000ROA\u2212i\ue0001\u2212t\ue001 \ue001\ue001
with
ROE=ROA\ue000D
E\ue000ROA\u2212i\ue0001\u2212t\ue001 \ue001andROA=
gU
\ue0001\u2212payout \ue001
gL=\ue0001\u2212 payout\ue001\u00d7\ue000
gU
\ue0001\u2212payout \ue001\ue000D
E\ue000
gU
\ue0001\u2212payout \ue001\u2212i\ue0001\u2212t\ue001\ue001\ue001
gL=\ue000gU\ue000D
E\ue000gU\u2212\ue0001\u2212 payout\ue001\u00d7i\ue0001\u2212t\ue001\ue001\ue001
gL=\ue0001\ue000D
E\ue001\u00d7gU \u2212\ue000D
E\u00d7\ue0001\u2212payout\ue001\u00d7i\ue0001\u2212t\ue001\ue001
Kurt Hess, kurthess@waikato.ac.nz
Page 2
Estimating Determining Growth Rates.xls
Visualizing Relationship Between Levered and Unlevered Growth Rate
Teaching model prepared by Kurt Hess, University of Waikato Management School
Payout
30.0%
300
Dividend Payout Ratio
D/(D+E)
23.1%
231
Leverage (L)
D/E
0.0%
Gearing = L/(1-L)
i
10.0%
100
Interest rate
t
33.0%
330
Tax rate
Growth Unlevered Firm As Input Parameter
6.5%
65
Growth Levered Firm0.0%
Breakeven
4.69% =(1-Payout)*i*(1-t)
Implied ROA
9.3%
Implied ROE
0.0%
gU
gL
(1+D/E)*gU - {D/E*(1-Payout)*i*(1-t)}
=gU/(1-Payout)
=gL/(1-Payout)
0%
2%
4%
6%
8 %
1 0 %
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1

0 %
4 0 %
7 0 %

B r e a k e v e n L in e
Growth Unlevered F
ir m
GrowthLever
edFirm
Kurt Hess, kurthess@waikato.ac.nz
Page 3
Estimating Determining Growth Rates.xls
40
70
0.00%
0%
40%
70%
0.00%
0.0%
0.0%
0.0%
1.00%
0.0%
0.0%
0.0%
2.00%
0.0%
0.0%
0.0%
3.00%
0.0%
0.0%
0.0%
4.00%
0.0%
0.0%
0.0%
5.0%
0.0%
0.0%
0.0%
6.00%
0.0%
0.0%
0.0%
7.00%
0.0%
0.0%
0.0%
8.00%
0.0%
0.0%
0.0%
9.00%
0.0%
0.0%
0.0%
10.00%
0.0%
0.0%
0.0%
11.00%
0.0%
0.0%
0.0%
Breakeven Line
4.7%
0.00%
4.7%
0.00%
6 %
8%
10%
12%
1

0%
40%
70%

Breakeven Line
U n le v e r e d F
irm