Profitability Ratios: Return on Assets (ROA) and Return on Equity (ROE)
An analyst is examining the valuation measures of a particular company and finds the following information:
|Valuation Measure | Value|
|---|---|
|Annual Dividend | USD 2.80|
|Dividend Payout | 40%|
|Return on Assets | 6% |
|Leverage| 2.0 |
Based on this information, the company's retention rate and sustainable growth rate, respectively, are _most likely_:
Incorrect.
Actually, 40% is the dividend payout rate, not the retention rate. The sustainable growth rate for this company is also higher than 4.8%.
Correct!
Based on the DuPont Model,
$$\displaystyle \mbox{ROE = ROA} \times \mbox{Leverage}$$
$$\displaystyle =0.06\times 2.0=0.12$$,
or 12%.
And the retention rate is equal to
$$\displaystyle (1- \mbox{Payout Rate})$$
$$\displaystyle =(1-0.40)=0.60$$,
or 60%.
Therefore, the sustainable growth rate is equal to
$$\displaystyle \mbox{ROE} \times \mbox{Retention}$$
$$\displaystyle =0.12\times 0.6= 0.072$$,
or 7.2%.
Incorrect.
The retention rate is higher than that given in this answer, and the sustainable growth rate for this company has been miscalculated here.
30% and 12%.
40% and 4.8%.
60% and 7.2%.
