A firm has $70 million in equity and $30 million of debt, it pays dividends of 30% of net income, and has a net income of $10 million. What is the firm's 'internal growth rate'?

Question

Quizplus · Accepted Answer

The internal growth rate can be calculated using the formula: (Retention Ratio * ROE). The retention ratio is the opposite of the payout ratio, so if the firm pays out 30% of its net income as dividends, it retains 70% of its net income. The Return on Equity (ROE) is net income divided by equity, so $10 million / $70 million = 14.29%. Thus, the internal growth rate = 70% * 14.29% = 10% * 14.29% = 10% of 14.29 = 1.429, which is approximately 10% of 14.29, rounding to the nearest whole number gives us 7%.

A Firm Has $70 Million in Equity and $30 Million