A firm expects growth next year to be 12%.Its sustainable growth rate is 10%.Which of the following is true?

Question

Quizplus · Accepted Answer

The sustainable growth rate is the growth rate a firm can maintain using only internal financing (retained earnings), without having to raise additional external financing such as debt or equity. Since the expected growth rate is higher than the sustainable growth rate, the firm will need additional financing. Option A can be eliminated because it suggests raising debt, which is not necessary since the sustainable growth rate assumes only internal financing. Option C can also be eliminated since raising equity is not necessary for the same reason. Option D is incorrect since the expected growth rate is only slightly higher than the sustainable growth rate, which may not result in excess cash. Option E is incorrect since there is no information provided to support this statement. Therefore, option B is correct since reducing dividends will lead to more retained earnings, allowing the firm to maintain its current debt-to-equity ratio.

A Firm Expects Growth Next Year to Be 12