Question

Baggai Enterprises has an ROA of 10 percent, retains 30 percent of earnings, and has an equity multiplier of 1.25. Mondale Enterprises also has an ROA of 10 percent, but it retains two-thirds of earnings and has an equity multiplier of 2.00.

1. What are the sustainable dividend growth rates for (A) Baggai Enterprises and (B)

Mondale Enterprises?

2. Identify the drivers of the difference in the sustainable growth rates of Baggai Enterprises and Mondale Enterprises.

Answer 1

Baggi Enterprises

The ROA = 10%

Or

Net profit / total Assets = 0.10

Or Total Assets = Net profit /0.10

Equity multiplier = Total Assets / Total Equity = 1.25

Or

(Net Profit /0.10 ) *(1/Total Equity ) = 1.25

Or Net profit / Total Equity = 1.25*0.10= 0.125

Or ROE = 12.5 %

Now

Growth rate (g) = ROE * retention rate %

Or 0.125* 0.30( as 30% is retention rate) = 0.0375 or 3.75 % is the growth rate

For Mondale Enterprises

The ROA = 10%

Or

Net profit / total Assets = 0.10

Or Total Assets = Net profit /0.10

Equity multiplier = Total Assets / Total Equity = 2

Or

(Net Profit /0.10 ) *(1/Total Equity ) = 2

Or Net profit / Total Equity = 2*0.10= 0.20

Or ROE = 20 %

Now

Growth rate (g) = ROE * retention rate %

Or 0.20* 0.6667( as 66.67% is retention rate) = 0.1334 or 13.34 % is the growth rate

B

The differences in the growth rate is due to the following reasons

· The Retention rate – Higher the retention of earnings by the firm , higher is the internal sustainable growth rate. Hence we can see the firm with higher retention of earnings is showing a greater growth rate

· ROE- Higher the return on the equity achieved by the company , greater is the growth of the company .

Thanks