Imagine a corporation with $1,000,000 of assets and a debt ratio of 40%. ROE (return on equity) is expected to be 20% for the foreseeable future. Assume the firm keeps the same amount of debt indefinitely (as opposed to keeping the same debt ratio).
a. What do you expect the firm's earnings to be for the next 3 years if the firm doesn't pay out any dividends or re-purchase any shares?
b. If the firm doesn't pay any dividends or re-purchase any shares, at what rate would the firm grow from year to year?
c. If the firm pays 50% of its earnings as dividends, at what rate would the firm grow from year to year?
d. If the firm uses 80% of its earnings to re-purchase shares from its shareholders, at what rate would the firm grow from year to year?
e. If the firm pays 50% of its earnings as dividends, and uses an additional 20% of its earnings to re-purchase shares from its shareholders, at what rate would the firm grow from year to year?
f. What does the term Sustainable Growth Rate mean? Would the amounts you have calculated in parts b. to d. equal the Sustainable Growth Rate for the firm?