1. An all-equity-financed firm plans to grow at an annual rate of at least 28%.
ID: 2594197 • Letter: 1
Question
1. An all-equity-financed firm plans to grow at an annual rate of at least 28%. Its return on equity is 43%. What is the maximum possible dividend payout rate the firm can maintain without resorting to additional equity issues? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
2. The 2017 financial statements for Growth Industries are presented below.
Sales and costs are projected to grow at 20% a year for at least the next 4 years. Both current assets and accounts payable are projected to rise in proportion to sales. The firm is currently operating at 75% capacity, so it plans to increase fixed assets in proportion to sales. Interest expense will equal 10% of long-term debt outstanding at the start of the year. The firm will maintain a dividend payout ratio of 0.50.
What is the required external financing over the next year? (Negative amounts should be indicated by a minus sign.)
INCOME STATEMENT, 2017 Sales $ 210,000 Costs 155,000 EBIT $ 55,000 Interest expense 11,000 Taxable income $ 44,000 Taxes (at 35%) 15,400 Net income $ 28,600 Dividends $ 14,300 Addition to retained earnings 14,300Explanation / Answer
(I am solving the first part of the question as I am confident about the solution)
Solution(1): Calculation of maximum possible dividend payout rate:-
When a firm is 100% equity financed, then the total assets equal total equity and ROA equals ROE.
Therefore, Internal growth rate = Plowback ratio*ROE*(Equity/Assets) = Plowback ratio*ROA
or, 0.28 = Plowback ratio* 0.43
or, Plowback ratio = 0.28/0.43 = 0.651 or 65.1%
Therefore, Dividend payout ratio = 1- Plowback ratio
= 1-0.651 = 0.349 or 34.9%
If the firm wants to remain 100% equity financed and avoid any additional equity financing, the firm must keep its dividend payout ratio at 34.9% or lower to achieve its desired growth rate.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.