 # DDM Question

It is January 1, 20X7, and George Smith, CFA, is analyzing Key Corporation (NYSE: KEY), a maker of car security system, which trades on NYSE at \$40 per share. KEY has just signed a contract with TOYO Motor Manufacture Co. to supply car security systems for all motors produced by TOYO in the next three years. George predicts that, because of the new contract, Key Corporation’s earnings and dividends will grow at 12% for the next three years. After that, the company’s growth is expected to decline to its long-term growth rate of 2.5% and remain at that level thereafter. In addition, Smith collected the following 20X6 year-end financial information on KEY: Trailing P/E: 22 Return on assets (ROA): 5.5% Equity multiplier (total assets / equity): 1.8 Net income: \$256 million Dividend per share: \$0.73 He estimates the cost of equity for Key Corporation, given its business and financial risk, to be 7.5%. Smith decides to first examine Key Corporation without consideration of the contract. He wants to look at the company’s sustainable growth rate, based on the historical results. Which of the following is closest to the firm’s sustainable growth rate for 20X7 (use only 20X6 year-end data in making this calculation)? A)5.94% B)9.90% C)3.96% D)16.50%

C

A. If ROA is 1.8, Assets = 4654, Equity = 2585, ROE = 9.9%, EPS = 1.82, Ret Rate = .6, g = 5.9%

^+1

I think I had one of those 6th grade math errors to get EPS @ 1.22

I second A. ROE = ROA*EqMult = 5.5%*1.8=9.9% RR = 1-Div/(P/(P/E))= 1 - 0.73*22/40=0.60 g = ROE*RR = 9.9%*0.6=5.94%

Stupid question but how do you get EPS?

EPS = P/(P/E)=40/22= \$1.82

Hm… stupid question indeed. Thanks maratikus!

it was not a stupid question. I should’ve specified though that it was trailing P/E = P/trailing EPS -> the formula worked and it would’ve been wrong if it was leading P/E. Then the formula would’ve given expected EPS

another great question, try as i may, i could not figure out the E, i think reading off a screen rather than on paper really confuses me A

A same as you cjb, I had to write down the figures on paper to get it clear

Sorry for the late post. Was at a conference the last two days. The ans is indeed A. And some of you have shown the correct working. FYI the question was from stalla

its A 1luv