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Economic Growth Model AGEC 489-689 Spring 2010

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Know this equation

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Economic Growth Model ROE = [(r – i)L + r](1 – tx)(1 – w) Rate of return on assets Cost of debt capital Leverage ratio or debt/equity Income tax rate Rate of withdrawals from firm

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Economic Growth Model ROE = [(r – i)L + r](1 – tx)(1 – w) There are many applications of this model: 1.Solve for ROE given r, i, L, tx and w 2.Solve for required r given ROE, i, L, tx and w 3.Solve for maximum w for required ROE given r, i L and tx 4.Solve for maximum L for required ROE given r, i tx and w Basically we can treat this as one equation with one unknown and solve for that unknown value. This allows us to examine the effects internal and external constraints of specific internal and external constraints on the growth of the firm’s equity base.

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Note the use of leverage here increases the ROE…

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New set of conditions Page 55 in booklet

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