2. The following table provides summary data for Target on May 2, 2014, per fina

Question

2. The following table provides summary data for Target on May 2, 2014, per finance.yahoo.com (in billions). Analysts often use the observed PB ratio to infer market expectations regarding a company’s future performance based on assumptions. Assuming that the market’s expectation of Target’s future ROE is consistent with its past performance and its discount rate is expected to be 7.5%, compute Target’s implied future growth rate. Target Market value of equity $39.30 Book Value of Equity $16.49 ROE 11.46% 2. The following table provides summary data for Target on May 2, 2014, per finance.yahoo.com (in billions). Analysts often use the observed PB ratio to infer market expectations regarding a company’s future performance based on assumptions. Assuming that the market’s expectation of Target’s future ROE is consistent with its past performance and its discount rate is expected to be 7.5%, compute Target’s implied future growth rate. Target Market value of equity $39.30 Book Value of Equity $16.49 ROE 11.46%

Explanation / Answer

Solution:

Market value of equity = $39.30

Book value of equity = $16.49

ROE = 11.46%

PB ratio = $39.30 / $16.49 = 2.38326

Price book difference = 2.38326 -1 = 1..38326

Let growth rate = g

Discount rate = 7.5%

Implied parameter:

Discount rate = [ROE + (PB difference * g)] / (1 + PB difference)

0.075 = [0.1146 + (1.38326 * g)] / (1+1.38326)

0.17874 = 0.1146 + 1.38326 g

g = 4.64%

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