CA Final · Advanced Financial Management · Security Analysis
Arvind Textiles Ltd expects an EPS of Rs 12 next year. It plans to retain 40% of earnings, and its return on equity is 15%. Using the constant growth approach (g = b x ROE), what is the expected sustainable growth rate of earnings and dividends?
The sustainable growth rate is 6%, obtained by multiplying the retention ratio of 40% by the return on equity of 15%. Using the 60% payout ratio instead would wrongly give 9%.
- A6%
- B9%Correct
- C15%
- D40%
Explanation
Retention ratio b = 40% = 0.40 and ROE = 15%. g = 0.40 x 15% = 6%. Wait: 0.40 x 15 = 6, so the correct figure is 6%, and 9% would result from using the payout ratio 60% instead of retention (0.60 x 15).
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