Question

For a firm with $3 million in total assets, $400,000 in net income, and $150,000 in dividend payments, first calculate the maximum rate of growth in sales without tapping external sources of funds. Next, show how that growth rate changes if the dividend payout ratio is reduced to 20 percent. Do these two points suggest that shareholders must be willing to trade dividends for growth?

Answer 1

internal growth rate=RoA*(1-payout)/(1-RoA*(1-payout))=400000/3000000*(1-150000/400000)/(1-400000/3000000*(1-150000/400000))=9.09%

If dividend payout ratio changes to 20%

internal growth rate=400000/3000000*(1-20%)/(1-400000/3000000*(1-20%))=11.94%

If dividend payout decreases growth rate increases

But it depends on capital gains and dividend taxation and clientele effect-the proportion of shareholders of the company who want regular income or current dividends more than the future growth, whether shareholders should be willing to trade dividends for growth. If we ignore these factors, shareholders should be willing to trade dividends for growth