ACCA Strategic Professional · Advanced Financial Management · Valuation and the use of free cash flows
Zenith plc has a current return on equity of 16% and retains 40% of its earnings. Using the formula g = retention rate x return on new investment, and assuming the return on new investment equals the current return on equity, what is the estimated sustainable annual dividend growth rate?
The sustainable growth rate is 6.4%, found by multiplying the retention rate of 40% by the return on equity of 16%. Growth depends on the proportion of earnings reinvested, not on the proportion paid out as dividends.
- A6.4%Correct
- B9.6%
- C10.0%
- D16.0%
Explanation
g = b x r = 0.40 x 16% = 6.4%. The 9.6% figure comes from using the payout ratio (60%) instead of the retention ratio. The 16% figure ignores retention altogether.
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