Metronic has $70M in equity and $30M in debt and forecasts $14M in net income fo
ID: 2645520 • 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 sustainable 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
Sustainable growth rate= Return on equity * (1- Dividend pay out ratio)
return on equity = Net income/Equity.
Net income = $14,000,000
Return on equity = $14,000,000/$70,000,000
=20%.
Dividend payout ratio = 30%
Sustainable growth rate when dividend pay out ratio =20% is 0.20*(1-.20) =0.20*0.80 =0.16
Sustainable growth rate when dividend pay out ratio is 30% = 20%(1-.30) =0.20*0.70 =0.14
Internal growth rate = (ROA * retention ratio/(1-ROA * retention ratio))
Return on assets =14,000,0000/(Equity+Debt)
=(14,000,000/100,000,000 ) * 100 =14%.
Internal growth rate when dividend pay out ratio is 20% = (14%*80%)/1-(14%*80%)= 0.112/1-0.112
=(0.112/0.888)* 100
=0.126126.
Internal growth rate when dividend pay out ratio is 30% =(14%* 70%)/(1-(14%* 70%))
=0.098/0.902
=0.108647