If a firm pays out 3020% of its earnings as dividends and has averaged a 20 percent return on equity, how quickly can the firm grow while maintaining a constant debt to equity mix?

Question

Quizplus · Accepted Answer

The sustainable growth rate (SGR) is calculated as:

SGR = Retention rate × Return on equity

Where the retention rate is equal to 1 − dividend payout ratio.

In this case, the dividend payout ratio is 3020% which is not possible, as it exceeds 100%. Therefore, assuming a typo and changing it to 30%, the retention rate would be:

Retention rate = 1 − payout ratio = 1 − 0.30 = 0.70

And the SGR would be:

SGR = 0.70 × 0.20 = 0.14 or 14%

Therefore, the firm can grow at a maximum rate of 14% while maintaining a constant debt to equity mix. Among the provided answer choices, the closest one to 14% is option C, 16.3%.

If a Firm Pays Out 3020% of Its Earnings as Dividends