Internal and Sustainable Growth Rates and Payout Policy (Berk et.

al)

Example:

Your firm has $70 million in equity and $30 million in debt and forecasts $14 million in net income for
the year. It currently pays dividends equal to 20% of its net income. You are analyzing a potential change
in payout policy - an increase in dividends to 30% of net income. How would this change affect your
internal and sustainable growth rates?

Net Income = $14M

Debt = $30M
Equity = $70M
Total Assets = $100M

Solution:

Current Dividend Payout Ratio (1-b) = 0.20

Current Sustainable Growth Rate:

Current Internal Growth Rate:

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Proposed Dividend Payout Ratio (1-b) = 0.30

Proposed Sustainable Growth Rate:

Proposed Internal Growth Rate:

By reducing the amount of retained earnings available to fund growth, an increase in the payout ratio
necessarily reduces your internal and sustainable growth rates.

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