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ACCA Strategic Professional · Advanced Financial Management · Strategic business and financial planning for multinational organisations

Kestrel plc plans to finance growth entirely from internal funds. It has a return on equity of 16% and a retention ratio of 40%, and it keeps its capital structure and ROE constant. Using the sustainable growth model g = retention ratio x ROE, what is the expected growth rate in earnings, and what dividend payout ratio does it imply?

Growth is 6.4% with a 60% payout. Sustainable growth equals the retention ratio of 40% multiplied by the 16% return on equity, and the dividend payout is the remainder, 60% of earnings.

  1. A6.4% growth; 60% payoutCorrect
  2. B9.6% growth; 40% payout
  3. C6.4% growth; 40% payout
  4. D16.0% growth; 60% payout

Explanation

g = 0.40 x 16% = 6.4%. Payout ratio = 1 - retention = 60%. The 9.6% figure uses 60% x 16%, wrongly treating the payout as retention. The 16% figure ignores retention altogether.

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