Busy Bus and Van Lines, Inc. Growth Rate Analysis

Busy Bus and Van Lines, Inc.

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Question

A consulting firm is currently under contract with a Busy Bus and Van Lines, Inc., and has agreed to formulate various financial reports and trend projections for the Company. During the most recent month, the consulting firm has been able to determine the following; Busy Bus and Van Lines currently pays out 30% of its net income as dividends, and this rate is expected to remain stable. Additionally, Busy has maintained a steady ROE of 15% for the last ten years, and this is also expected to remain stable. The risk-free rate of return is 5.35%, and the firm is in a 35% combined state/federal income tax rate. Finally, Busy Bus and Van Lines has informed the consulting firm that its shareholders require a 12.5% or greater rate of return, and the firm's common stock is priced at $9.65. Using the

Retention Growth Rate method, which of the following most closely resembles the growth rate of Busy Bus and Van Lines, Inc.?

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A. B. C. D. E. F.

F

When security analysts estimate growth rates, the Retention Growth Rate method is often the method employed. In estimating growth using this model, the retention rate (defined as the percentage of net income that is retained within the firm and not distributed as dividends), is multiplied by the figure for ROE. The calculation of the answer in this example is as follows: {[1 - payout ratio 30%]

* ROE 15%}= 10.5%. This method is most useful when the growth rate or the components of the equation are expected to remain stable.

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