Suppose Ace, over the last few years, has had an 18 percent average return on equity...

Suppose Ace, over the last few years, has had an 18 percent average return on equity (ROE) and has paid out 20 percent of its net income as dividends. Under what conditions could this information be used to help estimate the firm’s expected future growth rate, g? Estimate ks using this procedure for determining g

Expert Solution

The sustainable growth rate (SGR) of an enterprise can be calculated using the formula g = ROE * (1- Dividend payout ratio). The sustainable growth rate is the maximum rate of growth that a company can sustain without having to finance growth with additional equity or debt. For a company to operate above its SGR, it would need to maximize sales efforts and focus on high-margin products and services.

Given the current example, the g will be calculated as 18 * (1-0.2) i.e. 14.4%.

Based on the SGR formula results, the company Ace can grow at a sustainable rate of 14.4% without having to issue additional equity or take on additional debt.

jeff jeffy answered 2 years ago

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