Question

A firm has adopted a policy whereby it will not seek any additional external financing. Given this, what is the maximum growth rate of the firm if it has net income of $12,000, total equity of $40,000, total assets of $80,000, and a 40 percent dividend payout ratio?

Answer 1

Answer:

9%

Explanation:

Given:

The net income = $12,000

Total equity = $40,000

Total assets = $80,000

Dividend payout ratio = 40%

Now,

Internal rate of return, r = $\frac{\textup{Net Income}}{\textup{Total Equity}}\times100\%$

or

Internal rate of return, r = $\frac{\textup{12,000}}{\textup{80,000}}\times100\%$

or  

Internal rate of return, r = 15%

and,

Retention ratio = 1 - Dividend payout ratio

= 1 - 0.40

= 0.60 or 60%

Now,

Growth rate = Retention ratio × Internal rate of return

or

Growth rate = 0.60 × 0.15

or

Growth rate = 0.09

or

Growth rate = 9%