A Firm Has a Debt Equity Ratio of 1/3, and Plans

question 67

Multiple Choice

A firm has a debt equity ratio of 1/3, and plans to grow at an annual rate of 10%.Its return on equity is 18%.What is the maximum payout ratio that a company can maintain without resorting to new equity issue?

• A)24%
• B)25%
• C)26%
• D)27% If = , then =
• Internal growth rate = Plowback ratio * ROE_BEG *
• )10 = Plowback ratio * .18 * .75
• Plowback ratio = .10/(.18 * .75) = .74 = 74%

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Definitions:

Buying a Put

Purchasing a put option, which is a financial contract that gives the buyer the right to sell an asset at a predetermined price within a specified time frame.

Prices Decline

A decrease in the cost of goods and services in an economy over a period.

Call Option

A financial derivative that gives the buyer the right, but not the obligation, to buy an asset at a specified price within a predetermined period.

Purchase

The act of acquiring goods or services in exchange for money or other compensation.