Question

Estimating Growth A firm has a constant dividend payout ratio. Last year the firm had net income of $30 million and paid out dividends of $6 million. The firm's return on equity is expected to be 13% for the foreseeable future. This stock's growth rate in dividends (g) should be

Answer 1

Solution :

The formula for calculating the growth rate is :

Growth rate = Return on equity * Retention Ratio

As per the information given in the question we have

Return on equity = 13 %

Net Income = $ 30,000,000    ;   Dividend Paid = $ 6,000,000   ;

We know that the Retention ratio is = ( Net Income - Dividend Paid ) / Net Income

Applying the available information in the formula we have

Retention Ratio = ( $ 30,000,000 - $ 6,000,000 ) / $ 30,000,000   

= $ 24,000,000 / $ 30,000,000

= 0.8

Thus Retention ratio = 0.8

Applying the information available in the formula for growth rate we have:

Growth rate = 13 % * 0.80

= 10.40 %

Thus Stock’s growth rate = 10.40 %