Question

. Company A expects to earn 10% of its book equity, and will reinvest 50% of that. Company B expects to earn 12% of its book equity, and will pay out 80% of its earnings to shareholders. Which company grows faster for the next year?

A. Company A

B. Company B

C. Same growth rate

D. Not enough information

Answer 1

Sustainable growth rate = Return on equity * Retention ratio
Company A
Return on equity =				10%
Reinvestment means retention ratio =				50%
So, Sustainable growth rate = 10% * 50%
		5.00%
Company B
Return on equity =				12%
Payout ratio = 80%
so, retention ratio = 1-0.80 = 0.20 or				20%
So, Sustainable growth rate = 12% * 20%
		2.40%
Growth rate of Company A is 5.00% more than company B's growth 2.4%.
So, Company A will grow faster. Answer is A