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ESTIMATION OF GROWTH RATES The value of a firm is ultimately determined not by current cash flows but by expected future cash flows. The estimation of growth rates in earnings and cash flows is therefore central to doing a reasonable valuation. Growth rates can be obtained in many ways: they can be based upon past growth; drawn from estimates made by other analysts who follow the firm; or related to the firm's fundamentals. Since each of these approaches yields some valuable information, it makes sense to blend them to arrive at one composite growth rate to use in the valuation. This chapter examines different approaches to estimating future growth, and discusses the determinants of growth. Question 1 - Arithmetic and Geometric Means The…show more content…
ï It could reduce the dividend payout ratio to 50% and reinvest more back into the business. A. What is the expected growth rate in earnings, assuming that 1993 numbers remain unchanged? B. What is the expected growth rate in earnings, if the restructuring plan described above is put into effect? C. What will the beta of the stock be, if the restructuring plan is put into effect? Question 6 - Adjusting Inputs For Firm Type Computer Associates makes software that enables computers to run more efficiently. It is still in its high-growth phase and has the following financial characteristics: Return on Assets = 25% Dividend Payout Ratio = 7% Debt/Equity Ratio = 10% Interest rate on Debt = 8.5% Corporate tax rate = 40% It is expected to become a stable firm in ten years. A. What is the expected growth rate for the high-growth phase? B. Would you expect the financial characteristics of the firm to change once it reaches a steady state? What form do you expect the change to take? C. Assume now that the industry averages for larger, more stable firms in the industry are as follows: Industry Average Return on Assets = 14% Industry Average Debt/Equity Ratio = 40% Industry Average Interest Rate on Debt = 7% Industry Average Dividend Payout ratio = 50% D. What would you expect the growth rate in the stable growth phase to be? Question 7 - Weighting Different Estimates of Growth Rate The following are a number of
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