The sustainable growth rate g equals ROE times the retention ratio. If ROE is 20% and retention ratio is 0.4, what is g?

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Multiple Choice

The sustainable growth rate g equals ROE times the retention ratio. If ROE is 20% and retention ratio is 0.4, what is g?

Explanation:
The growth a company can sustain without changing its financial structure depends on reinvesting earnings and the return those investments generate. This rate, the sustainable growth rate, is calculated as ROE times the retention (plowback) ratio. With ROE at 20% and a retention ratio of 0.4, g = 0.20 × 0.40 = 0.08, or 8%. So the sustainable growth rate is 8%. If you plug in different numbers, 4% would require a retention of 0.2, 12% would require 0.6, and 16% would require 0.8, which don’t match the given retention ratio.

The growth a company can sustain without changing its financial structure depends on reinvesting earnings and the return those investments generate. This rate, the sustainable growth rate, is calculated as ROE times the retention (plowback) ratio. With ROE at 20% and a retention ratio of 0.4, g = 0.20 × 0.40 = 0.08, or 8%. So the sustainable growth rate is 8%. If you plug in different numbers, 4% would require a retention of 0.2, 12% would require 0.6, and 16% would require 0.8, which don’t match the given retention ratio.

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