ABC Corp.has an ROE of 20% and a current dividend payout ratio of 40%.Which of the following changes will allow its earnings to grow at a 15% rate?
A) A decrease in the dividend payout ratio to 35% 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% while holding ROE constant
D) An increase in dividend payout ratio to 50% and an increase in ROE to 25%

Question

Quizplus · Accepted Answer

In order to achieve earnings growth of 15%, the company needs to retain a larger portion of its earnings and therefore decrease the dividend payout ratio. Option A is incorrect because decreasing the dividend payout ratio to 35% is not a significant enough change to allow for an earnings growth of 15%. Option B is incorrect because decreasing the ROE would result in a decrease in earnings growth. Option D is incorrect because increasing the dividend payout ratio and ROE would result in a larger dividend payout to shareholders, leaving less earnings to be retained and reinvested in the company. Therefore, decreasing the dividend payout ratio to 25% while holding ROE constant is the best choice.

ABC CorpHas an ROE of 20% and a Current Dividend Payout