A firm projects net income to be $500,000, intends to pay out $125,000 in dividends, and had $2 million of equity at the beginning of the year. The firm's sustainable growth rate is:

The sustainable growth rate (SGR) is the maximum rate of growth that a company or social enterprise can sustain without having to finance growth with additional equity or debt. In other words, it is the rate at which the company can grow while using its own internal revenue without borrowing from outside sources.
The SGR formula is most commonly used in various valuation models, such as the dividend discount model (DDM), discounted cash flow model, etc.

Calculation of SGR :-

1) Calculate the retention ratio

retention ratio = 1 - dividends paid / net income

2) Calculate the return on equity (ROE)

ROE = net income / shareholders' equity

3) Calculate the sustainable growth rate (SGR)

SGR = retention ratio × ROE

Hence, by using the above formula the sustainable growth rate of the firm is 18.75%

To know more about sustainable growth rate, click the given links.

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Correct Question - A firm projects net income to be $500,000, intends to pay out $125,000 in dividends, and had $2 million of equity at the beginning of the year. The firm's sustainable growth rate is:

a. 5%

b. 18.75%

c. 6.25%

d. 4.69%