Peterson's Potential Growth Rate

C

To determine the potential growth rate of Peterson Manufacturing, we need to consider the effects of increased leverage and a higher dividend payout ratio.

1. Increased Leverage: When a company increases its financial leverage by issuing debt, it typically takes on additional interest expenses. This can affect the company's profitability and, consequently, its growth potential. The increased interest expense will reduce the net income available for reinvestment and can constrain the company's ability to finance growth initiatives.

As a result, the potential growth rate of Peterson Manufacturing may be impacted negatively due to the increased leverage. This is because a portion of the earnings will be allocated to interest payments instead of being reinvested in the business.

2. Higher Payout Ratio: A higher dividend payout ratio means that Peterson Manufacturing will distribute a larger portion of its earnings as dividends to shareholders. By increasing the dividend payout ratio, the retained earnings available for reinvestment in the company's growth initiatives will decrease.

A higher dividend payout ratio can be seen as a signal to investors that the company is mature and does not require substantial reinvestment for growth opportunities. While higher dividends may be appreciated by shareholders, it can reduce the company's ability to finance future growth projects.

Now, let's analyze the provided answer choices:

A. will increase due to the increased leverage and increase further due to the higher payout ratio. This answer suggests that both increased leverage and a higher payout ratio will have a positive impact on the potential growth rate. However, this is incorrect. Increased leverage is more likely to have a negative impact on growth due to the additional interest expenses, whereas a higher payout ratio reduces the retained earnings available for reinvestment.

B. will increase due to the higher payout ratio, but this increase will be offset to some extent by the increased leverage. This answer acknowledges that a higher payout ratio will increase the potential growth rate. However, it also recognizes that increased leverage may partially offset the positive impact of the higher payout ratio. This option seems reasonable as increased leverage can impede growth due to higher interest expenses.

C. will increase due to the increased leverage, but this increase will be offset to some extent by the higher payout ratio. This answer suggests that the potential growth rate will increase due to increased leverage but will be partially offset by the higher payout ratio. This option aligns with the understanding that increased leverage can hinder growth while a higher payout ratio limits the retained earnings available for reinvestment.

Based on the analysis, option C is the most accurate answer to the question.