Corporate Finance: Instructor\'s Manual Applied Corporate Finance

Aswath Damodaran 502

Expected Growth in EPS

gEPS = Retained Earningst-1/ NIt-1 * ROE

= Retention Ratio * ROE

= b * ROE

• Proposition 1 : The expected growth rate in earnings for a company

cannot exceed its return on equity in the long term.

In the short term, improvements in return on equity will translate into more than

proportional increases in expected growth in earnings. In fact, the expected

growth in earnings per share in any year can be written as:

gEPS= b *ROEt+ 1 +{(ROEt+ 1 – ROEt)BV of Equityt)/ROEt (BV of Equityt)}

Note that the larger the firm, the greater the effect (in either direction) of changes

in ROE.