Measuring growth Given that a firms return on equity is 15 p

(Measuring growth) Given that a firm\'s return on equity is 15 percent and management plans to retain 42 percent of earnings for investment purposes, what will be the firm\'s growth rate? If the firm decides to increase its retention rate, what will happen to the value of its common stock? a. The firm\'s growth rate will be?% (Round to two decimal places.)

Solution

a.) Growth rate, g = b x r

where b = retention ratio

   r = return on equity

   = .42 x .15

   = .063 that is 6.3%

If the company decided to increase the retention ratio it means that it pays lesser dividend and retaining the money for future expansion. This will increase the expectation of the investors and the value of the common stock will go up.

However, whether a high growth rate would automatically translate into higher market price is debatable because share price is function of myriad parameters and not just dividends.