In the retention growth model, what is calculated by subtracting the payout ratio from one___________?
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Answer: C. Retention ratio
Explanation
The retention ratio measures the proportion of earnings retained within the business for reinvestment. Total earnings are divided between dividend payouts and retained earnings, summing to one hundred percent. Subtracting the dividend payout ratio from one mathematically yields the exact retention ratio percentage. The retention growth model uses the retention ratio multiplied by return on equity to forecast sustainable growth. Dividend payout ratio measures the percentage of net income distributed as cash dividends to shareholders. Firms with high growth opportunities retain a larger portion of earnings rather than paying dividends.
Corporate financial planners use the retention ratio to estimate internal equity growth without external financing. Investors evaluate payout and retention ratios to determine whether a stock is an income or growth asset. Sustainable growth models help management balance dividend policies with long-term capital expansion plans. Option A refers to present value ratio, which discounts future cash flows rather than measuring earnings retention. Option B mentions future value ratio, which calculates compounding growth rather than earnings proportions. Option D suggests growth ratio, which represents a broader outcome rather than the specific earnings fraction.
- Subject
- Accounting and Finance
- Category
- Finance
- Topic
- —
- Difficulty
- medium
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