A firm has $20 million in equity and $20 million of debt,it pays dividends of 20% of net income,and has a net income of $5 million.What is the firm's sustainable growth rate?

Question

Quizplus · Accepted Answer

The sustainable growth rate (SGR) is calculated as the Return on Equity (ROE) multiplied by the retention ratio (b), where the retention ratio is 1 minus the dividend payout ratio. Here, the dividend payout ratio is 20%, so the retention ratio is 80% or 0.8. Assuming the $5 million net income is all from equity (since no other information is provided), the ROE is $5 million / $20 million = 25%. Therefore, SGR = ROE * b = 25% * 0.8 = 20%.

A Firm Has $20 Million in Equity and $20 Million