INV3701, ASSIGNMENT 1, SEMESTER 1, 2026
INV3701
INVESTMENTS: EQUITY ASSET VALUATION
ASSIGNMENT SUGGESTED SOLUTIONS
SEMESTER 1
ASSIGNMENT 01
DUE: Wednesday, 18 March 2026, 9:00 PM.
Aim: To evaluate your knowledge of some of the fundamental aspects of equity
valuation: application and process, equity return concepts, the dividend
discount model and free cash flow models. Refer to lessons 1 to 4, which include
chapters 1, 3 to 5, and 7 to 8 in the prescribed book.
…………………………………………………………………………………………………
QUESTION 1
QUESTION 1.1
An equity analyst states that for a firm to maintain a sustainable growth rate, the
following assumptions must hold:
Statement 1: The firm may issue additional common stock.
Statement 2: The firm’s capital structure may change over time.
Briefly justify whether the above statements are correct.
Both statements are incorrect.
1
, INV3701, ASSIGNMENT 1, SEMESTER 1, 2026
SUSTAINABLE GROWTH RATE is the rate of dividend (and earnings) growth
§ that can be sustained for a given level of return on equity
§ assuming that the capital structure is constant through time and that
additional common stock is not issued
Statement 1 is false
• Sustainable growth rate (SGR) is the maximum rate a firm can grow
using only internally generated equity (retained earnings) while keeping
its financial policies unchanged. It assumes no new common stock is
issued.
Statement 2 is false.
• SGR also assumes the firm maintains a constant target capital structure
(e.g., a constant D/E ratio). Debt can rise proportionally with equity to
keep the ratio unchanged, but the mix itself does not change.
QUESTION 1.2
Karoo Limited has a return on equity (ROE) and equity risk premium of 36% and 6.10%
respectively. Its shares are currently selling for R59.36 and it has a trailing 12-month
earnings and dividends per share of R3.84 and R1.42 respectively. The profit margin
on sales is 24.10%.
The estimated Fama-French factor sensitivity of Karoo and the risk premiums
associated with these factors are given in the table below:
Factor sensitivity Risk premium (%)
Market factor 0.50 7.1
Size factor 0.78 5.3
Value factor -0.64 1.6
Evaluate the expected style characteristics of Karoo Limited based on the given
factor sensitivities.
Karoo Limited displays a small-cap, growth, defensive style tilt.
Explanation:
2
INV3701
INVESTMENTS: EQUITY ASSET VALUATION
ASSIGNMENT SUGGESTED SOLUTIONS
SEMESTER 1
ASSIGNMENT 01
DUE: Wednesday, 18 March 2026, 9:00 PM.
Aim: To evaluate your knowledge of some of the fundamental aspects of equity
valuation: application and process, equity return concepts, the dividend
discount model and free cash flow models. Refer to lessons 1 to 4, which include
chapters 1, 3 to 5, and 7 to 8 in the prescribed book.
…………………………………………………………………………………………………
QUESTION 1
QUESTION 1.1
An equity analyst states that for a firm to maintain a sustainable growth rate, the
following assumptions must hold:
Statement 1: The firm may issue additional common stock.
Statement 2: The firm’s capital structure may change over time.
Briefly justify whether the above statements are correct.
Both statements are incorrect.
1
, INV3701, ASSIGNMENT 1, SEMESTER 1, 2026
SUSTAINABLE GROWTH RATE is the rate of dividend (and earnings) growth
§ that can be sustained for a given level of return on equity
§ assuming that the capital structure is constant through time and that
additional common stock is not issued
Statement 1 is false
• Sustainable growth rate (SGR) is the maximum rate a firm can grow
using only internally generated equity (retained earnings) while keeping
its financial policies unchanged. It assumes no new common stock is
issued.
Statement 2 is false.
• SGR also assumes the firm maintains a constant target capital structure
(e.g., a constant D/E ratio). Debt can rise proportionally with equity to
keep the ratio unchanged, but the mix itself does not change.
QUESTION 1.2
Karoo Limited has a return on equity (ROE) and equity risk premium of 36% and 6.10%
respectively. Its shares are currently selling for R59.36 and it has a trailing 12-month
earnings and dividends per share of R3.84 and R1.42 respectively. The profit margin
on sales is 24.10%.
The estimated Fama-French factor sensitivity of Karoo and the risk premiums
associated with these factors are given in the table below:
Factor sensitivity Risk premium (%)
Market factor 0.50 7.1
Size factor 0.78 5.3
Value factor -0.64 1.6
Evaluate the expected style characteristics of Karoo Limited based on the given
factor sensitivities.
Karoo Limited displays a small-cap, growth, defensive style tilt.
Explanation:
2
