Question

J firm has a return on equity of 15 percent, a return on assets of 10 percent, and a 30 percent dividend payout ratio. The maximum growth rate only using internal financing is ____ and that using external financing and maintaining debt ratio is _____

a. 11.73% ; 7.53%
b. 7.53% ; 11.73%
c. 3.09% ; 4.71%
d. 4.71% ; 3.09%

Answer 1

The maximum growth rate with internal financing for J firm is calculated as the retention ratio multiplied by the return on equity, which gives us 10.5%. The growth rate with external financing is not determinable with the provided data since additional financial details are necessary.

Step-by-step explanation:

The question involves calculating the maximum growth rate a company can achieve with internal or external financing while maintaining its current debt ratio. The formula to calculate the maximum growth rate with internal financing is the retention ratio (which is 1 minus the dividend payout ratio) multiplied by the return on equity (ROE). This is known as the sustainable growth rate. Given a 30% dividend payout ratio, the retention ratio would be 70% or 0.7. To calculate the sustainable growth rate: 0.7 (retention ratio) × 15% (ROE) = 10.5%.

The maximum growth rate with external financing while maintaining the same debt ratio involves the return on assets (ROA) because it considers both equity and debt. However, the information provided doesn't allow us to create a precise calculation, as we would also need to know the company's debt to equity ratio and additional financial details.