Firms in which of the following industries would likely have the highest earnings retention rate? Further, are firms in this industry are likely to be financed primarily through debt or equity?
Click on the arrows to vote for the correct answer
A. B. C. D. E. F.B
Of the industries listed, fiber optics networking would be expected to have the highest earnings retention rate. The fiber optics networking industry is characterized by a high degree of investment in research and development, along with a high growth rate and level of uncertainty. All of these factorsare conducive to a high retention rate, i.e. a low dividend payout ratio. Further, firms within industries associated with high growth rates and high levels of uncertainty are likely to be financed primarily with equity. This is reasoned by several factors, some of which include the following:
Firms in new industries typically have a balance sheet weighted heavily toward intangible assets, which can neither be easily liquidated nor pledged as collateral for a loan.
Firms in new industries are characterized by a high degree of research and development expenses.
Equity provides firms in emerging industries with a higher degree of agility than debt financing.
The cash flows of firms in developing industries are characterized by a high degree of uncertainty, which often prevents the reliable payment of debt obligations.