Assume the following information about a textile manufacturing company. Dividend retention rate = 0.20
Total assets / common equity = 2.01
Net income / sales = 0.09 -
Sales / total assets = 0.67 -
What is the expected annual growth rate of this firm's dividends?
Click on the arrows to vote for the correct answer
A. B. C. D. E. F.Explanation
The correct value for the growth rate of dividends for this textile-manufacturing firm is an abysmally low 2.42%. Thus, none of the answers is correct.
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 = [0.09 * 0.67 * 2.01] = 0.121203, or 12.12%.
Now that the ROE figure has been determined, the calculation of the growth rate of dividends is as follows: g = [(0.20) * 0.1212] = 0.02424, or 2.42%