ABC Corp.has an ROE of 20 percent and a current dividend-payout ratio of 40 percent.Which of the following changes will allow their earnings to grow at a 15 percent rate?
A)A decrease in the dividend-payout ratio to 35 percent while holding ROE constant
B)A two-percentage-point decrease in ROE while holding dividend-payout ratio constant
C)A decrease in dividend-payout ratio to 25 percent while holding ROE constant
D)An increase in dividend payout ratio to 50 percent and an increase in ROE to 25 percent current earnings growth rate = plowback ratio x ROE
= )6 x .20 = 12%
Desired earnings growth rate = plowback ratio x ROE

Question

Quizplus · Accepted Answer

The formula for earnings growth rate is plowback ratio x ROE. To increase earnings growth rate to 15 percent, the plowback ratio needs to be increased while keeping ROE constant. This means decreasing the dividend-payout ratio. Choice C decreases the dividend-payout ratio to 25 percent, which leaves more earnings to be retained and reinvested in the business. Choices A and D do not increase the plowback ratio enough to achieve the desired earnings growth rate, while choice B decreases the ROE, which would lead to a decrease in earnings growth rate.

ABC CorpHas an ROE of 20 Percent and a Current Dividend-Payout