Medtronic Company has an expected ROE of 16%.The dividend growth rate will be ________ if the firm follows a policy of paying 70% of earnings in the form of dividends.

Question

Quizplus · Accepted Answer

Using the dividend payout ratio formula (dividends/earnings), we can solve for the expected dividend growth rate: 
0.70 = dividends/earnings 
dividends/earnings = 0.70 
dividends = 0.70 * earnings 
Assuming a constant growth rate, we can use the Gordon Growth Model: 
ROE = (dividends/equity) + growth rate 
16% = (0.70 * earnings)/equity + growth rate 
16% - (0.70 * earnings)/equity = growth rate 
Since we know the expected ROE is 16%, we can plug that in: 
16% - (0.70 * 16%)/equity = growth rate 
growth rate = 4.8%

Medtronic Company Has an Expected ROE of 16