Question

AD Corporation's return on assets is 14% and the firm retains 40% of all its earnings. AD's internal growth rate is _____ %.

A) 8.4%
B) 6.0%
C) 4.2%
D) 5.6%

Answer 1

The internal growth rate of AD Corporation, calculated using its return on assets of 14% and retaining 40% of earnings, is approximately 5.93%, which rounds to the closest option, B) 6.0%.

Step-by-step explanation:

The internal growth rate is a measure of how much a company can grow using only its own resources without needing to resort to external funding such as debt or equity. The internal growth rate can be calculated using the return on assets (ROA) and the retention ratio (b), which is the proportion of earnings retained as opposed to distributed to shareholders. The formula for the internal growth rate is:

Internal Growth Rate = ROA * b / (1 - (ROA * b))

In this case, AD Corporation has a return on assets (ROA) of 14% (0.14) and retains 40% of its earnings (0.40). Inserting these values into the formula gives:

Internal Growth Rate = 0.14 * 0.40 / (1 - (0.14 * 0.40))

Internal Growth Rate = 0.056 / (1 - 0.056)

Internal Growth Rate = 0.056 / 0.944

Internal Growth Rate ≈ 5.93%

Thus, the closest option to the calculated internal growth rate is B) 6.0%.