Music Doctors Company has an expected ROE of 14%.The dividend growth rate will be ________ if the firm follows a policy of paying 60% of earnings in the form of dividends.

Question

Quizplus · Accepted Answer

The dividend payout ratio is 60%, which means that the retention ratio (the portion of earnings that is not paid out as dividends) is 40%. Therefore, the sustainable growth rate (g) can be calculated as follows: 
g = ROE x retention ratio
g = 14% x 40% = 5.6%
Hence, the dividend growth rate will be 5.6%. Therefore, the correct answer is (B).

Music Doctors Company Has an Expected ROE of 14