What is the sustainable growth rate of the company that enjoys return on equity = 30 percent and a dividend payout ratio of 40 percent?

Correct option is B

The Sustainable Growth Rate (SGR) is the maximum rate at which a company can grow its sales, earnings, and dividends without raising external equity capital while maintaining a constant debt-to-equity ratio. It is determined using the following formula:

SGR = ROE×(1−Dividend Payout Ratio)

Where:

• ROE (Return on Equity) = 30%
• Dividend Payout Ratio = 40%
• Retention Ratio (b) = 1 - Dividend Payout Ratio = 1 - 0.40 = 0.60 (or 60%)

SGR = 30% × 60%
SGR = 30% × 0.60
SGR = 18%
Thus, the sustainable growth rate (SGR) is 18%, meaning the company can grow at a rate of 18% annually without requiring external financing.

Information Booster:​

1. SGR Significance: It indicates how fast a company can grow using only internally generated funds.
2. Impact of Dividend Payout Ratio: A higher dividend payout ratio reduces SGR because less profit is retained for reinvestment.
3. Effect of ROE on SGR: Higher ROE leads to higher SGR, as more earnings are generated on shareholder equity.
4. Companies with High SGR: Tech companies and firms with low dividend payouts tend to have higher sustainable growth rates.
5. Comparison with Actual Growth: If actual growth exceeds SGR, the company may need external financing (debt or new equity issuance).
6. Use in Financial Planning: Helps managers determine whether the company needs additional capital for expansion.