Question

BFC Ltd. has the following financial information:

Net Profit: $5 million; Sales: $100 million; Total Assets: $50 million; Equity $22.73 Million; Earnings Per Share (EPS): $3.00; Dividends Per Share: $1.00.

What is BFC’s return on equity and the estimated sustainable growth rate?

In general, how would the growth rate and payout ratio of value firms be different from growth firms? Explain why.

Answer 1

Return on equity= Net profit/Equity= $5/$22.73=22%

Sustainable growth rate=retention ratio*Return on equity

Dividend payout ratio= DPS/EPS=1/3=33.33%

Retention ratio=1-dividend payout ratio=1-33.33%=66.67%

Sustainable growth rate= 66.67%*22%=14.67%

b. Value firms are the firm's which will have low P/E ratio and is undervalued. In the future it will have strong profit potential. In general, for the value firms, the dividend payout ratios will be high.

For growth firms, the firm's will be in full expansion mode. During this phase, company will not pay any dividends and entire net profits will used for expansion of the business. But, the growth rates will be high for growth firms