Calculating Expected Annual Growth Rate of Dividends for a Manufacturing Company

D

A popular model for determining the growth rate of dividends is the following: g = RR * ROE

Where: g = the expected growth rate of dividends, RR = the retention rate (this is equal to 1 - dividend payout ratio), and ROE = the return on equity.

Although it may at first appear otherwise, all of the necessary information has been provided. Remember the Du Pont decomposition process for ROE, which breaks down the ROE figure into the following:

ROE = (Net Income / Sales) * (Sales / Total Assets) * (Total Assets * Common Equity)

Mathematically, this will break down into (Net Income / Common Equity), the ROE figure. The calculation of the return on equity for this company is as follows:

ROE = [0.14 * 0.85 * 2.2] = 0.2618, or 26.18%.

Now that the ROE figure has been determined, the calculation of the growth rate of dividends is as follows: g = [(1 - 0.50) * 0.2618] = 13.09%