Metronic has $70M in equity and $30M in debt and forecasts $14M in net income fo
ID: 2645519 • Letter: M
Question
Metronic has $70M in equity and $30M in debt and forecasts $14M in net income for the year. It currently pays dividends equal to 20% of its net income. You are analyzing a potential change in payout policy -an increase in dividends to $30% of net income. How would this change affect your internal and sustainable growth rates?
What is the internal growth rate of Metronic under the current payout policy?
Note: Express your answers in strictly numerical terms. For example, if the answer is 5%, write 0.05
Explanation / Answer
Case 1 - 20% Dividend payout ; 80% retention Internal growth rate (IGR)= ROA (Retention ratio)/ (1-ROA) * (retentio ratio) = ROA = net income / total assets = 14 M / 100 M = 0.14 Retention ratio = 1 - dividend payout ratio = 1-0.20 = 0.80 IGR = (0.14 * 0.80) / (1 - 0.14) (0.80) = 0.162791 = 16.28% Sustaintable growth rate (SGR)= ROE * retention ratio ROE = Return on equity = net income / equity SGR = (0.14 /0.70) * 0.80 = 0.16 = 16% Case2 - 30% Dividend payout ; 70% retention Internal growth rate (IGR)= ROA (Retention ratio)/ (1-ROA) * (retentio ratio) = ROA = net income / total assets = 14 M / 100 M = 0.14 Retention ratio = 1 - dividend payout ratio = 1-0.30 = 0.70 IGR = (0.14 * 0.70) / (1 - 0.14) (0.70) = 0.162791 = 16.28% Sustaintable growth rate (SGR)= ROE * retention ratio ROE = Return on equity = net income / equity SGR = (0.14 /0.70) * 0.70 = 0.14 = 14% Answers: By increasing the dividend payout to 30%, IGR remains the same. SGR decreases by 2% IGR under current policy is = 16.28%