Page 32 - FINAL CFA II SLIDES JUNE 2019 DAY 7

LOS 29.o: Calculate and interpret the sustainable growth rate of a READING 29: DISCOUNTED DIVIDEND VALUATION
company and demonstrate the use of DuPont analysis to estimate
a company’s sustainable growth rate.
MODULE 29.3: MULTIPERIOD MODELS

SGR is the rate at which earnings (and dividends) can continue to grow indefinitely,
assuming that the firm’s debt-to-equity ratio is unchanged and it doesn’t issue new equity.

SGR = g = b × ROE
Important because it tells us how quickly a firm can grow with internally generated funds.
where:
b = earnings retention rate = 1 − dividend payout rate
ROE = return on equity Answer: g = (1 − 0.20) × (15%) = 12%

EXAMPLE: Calculating SGR: Biotechnica, Inc., is growing earnings at an annual rate of 9%. It currently pays out dividends equal to 20% of earnings.
Biotechnica’s ROE is 15%. Calculate its SGR.

Also called the PRAT model:
SGR = f = is function of the profit margin (P), the retention rate (R), the
asset turnover (A), and financial leverage (T)..
Your growth rate (g) is linked to performance decisions (P/A) as well as your
financing decisions (R/T)

If the actual growth rate is forecasted to be greater than SGR, the firm
will have to issue equity unless the firm increases its retention ratio, profit
margin, total asset turnover, or leverage.

NOTE: Technically, ROE for SGR purposes should be on beginning shareholders’ equity. Average too is acceptable, use what exam question specifies!
EXAMPLE: Calculating ROE and SGR: Halo Construction has been successful in a mature industry. Over the last three years, Halo has averaged a profit margin of 10%,
a total asset turnover of 1.8, and a leverage ratio of 1.25. Assuming Halo continues to distribute 40% of its earnings as dividends, calculate its long-term SGR.