Question

(Measuring growth) Given that a firm's return on equity is 24 percent and management plans to retain 42 percent of earnings for investment purposes, what will be the firm's growth rate? If the firm decides to increase its retention rate, what will happen to the value of its common stock? a. The firm's growth rate will be %. (Round to two decimal places.) b. If the firm decides to increase its retention ratio, what will happen to the value of its common stock? (Select from the drop-down menus.) An increase in the retention rate will the rate of growth in dividends, which in turn will the value of the common stock.

Answer 1

a)

Growth rate = ROE * (1 - retention ratio)

= 24% * (1 - 0.42)

= 13.92%

b)

An increase in retention ratio decreases the rate of growth in dividends which in turn will decrease the value of common stock