A firm expects growth next year to be 12%. Its sustainable growth rate is 10%. Which of the following is true?
A)The firm will have excess cash to increase dividends, pay back debt, or repurchase equity.
B)The firm will need to raise additional capital through a stock issue.
C)The firm will need to raise additional debt such that its debt-to-equity ratio will increase.
D)The firm may be able to keep its debt-to-equity ratio the same by reducing dividends (assuming they are projected to be high enough).

Question

Quizplus · Accepted Answer

The sustainable growth rate of a firm is the rate at which it can grow without having to rely on external financing (i.e, issuing new equity or debt). If a firm expects growth higher than its sustainable growth rate, it will need to either reduce its dividend payout or raise additional capital. In this case, the firm's expected growth rate is 12% while its sustainable growth rate is 10%. Hence, the firm may be able to keep its debt-to-equity ratio the same by reducing dividends (assuming they are projected to be high enough).

A Firm Expects Growth Next Year to Be 12