As a result they became highly levered the conclusion

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Unformatted text preview: ends. This is also true, albeit to a lesser degree for Telesp Cellular. Low Growth As a firm increases the dividends it pays to stockholders, it is reinvesting less of its earnings back into its business. In the long term, this has to translate into lower growth in earnings per share.8 In fact, the long term sustainable growth rate in earnings per share for a firm can be written as a function of its payout ratio and the quality of its investments (measured by its return on equity): Expected Long-term Growth rate in earnings per share = (1- Payout ratio) (Return on equity) To illustrate, a firm that pays out 40% of its earnings as dividends and earns a 20% return on equity can expect to see its earnings per share grow 12% a year in the long term. Expected growth rate in earnings per share = (1 - .40) (.20) = .12 or 12% Investors who invest in companies that pay high dividends have to accept a trade off. These firms will generally have much lower expected growth rates in earnings. Consider again the sample of high divid...
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This note was uploaded on 01/17/2012 for the course ECON 101 taught by Professor Econnorm during the Spring '11 term at Art Institutes Intl. Minnesota.

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