Question

6. Your firm currently has net income to common equity of $1,500,000 and a dividend payout of 30%. If the firm’s return on assets is 10% and the return on equity is 8%, at rate of growth will dividends grow if the stock is currently publicly traded?

Answer 1

Dividends will grow at a sustainable growth rate.
The formula used to calculate sustainable growth rate is:
Sustainable growth rate=Return on equity*(1-dividend payout ratio)

Dividend payout is 30% of the net income to common equity.
Net income to common equity =$1,500,000
Dividend paid=$1500000*30%=$450000
Dividend payout ratio=Dividend paid /Net income=$450000/$1,500,000=.3
Return on equity=8%
Sustainable growth rate=Return on equity*(1-dividend payout ratio)
=>Sustainable growth rate=8%*(1-0.3)=8%*(0.7)=0.056 or 5.6%.