Z Corp. has an ROE of 15 percent and a dividend payout ratio of 60 percent. a. What is the company’s sustainable growth rate? b. Can the company’s growth rate be different from its sustainable growth rate? How so? (Hint: What does the sustainable growth rate assume about external financing?) c. How can the company increase its sustainable growth rate?
Sustainable growth rate = ROE×Retention ratio÷(1-ROE×Retention ratio)
Growth rate is the rate company expects to achieve using leverage and additional debt. Sustainable growth rate is the maximum growth rate company can achieve without additional external funds.
It can increase its sustainable growth rate either by increasing ROE and/or decreasing payout ratio.