ANSWER THE FOLLOWING 4 QUESTIONS. SHOW WORK 1) What is the internal growth rate?
ID: 1170851 • Letter: A
Question
ANSWER THE FOLLOWING 4 QUESTIONS. SHOW WORK
1) What is the internal growth rate?
2,244
$12,462
$12,462
$763
Assets and costs are proportional to sales. Debt and equity are not. The company maintains a constant 34 percent dividend payout ratio. No external equity financing is possible.
2) What is the sustainable growth rate?
The most recent financial statements for Live Co. are shown here:
10,200
$62,308
$62,308
$4,420
Assets and costs are proportional to sales. Debt and equity are not. The company maintains a constant 22 percent dividend payout ratio. No external equity financing is possible.
3)
The most recent financial statements for Throwing Copper Co. are shown here:
28,800
$109,350
$109,350
$10,530
Assets and costs are proportional to sales. The company maintains a constant 40 percent dividend payout ratio and a constant debt?equity ratio.
What is the maximum increase in sales that can be sustained assuming no new equity is issued?
4)
Explanation / Answer
Solution:-
1) Calculation of internal growth rate :-
Return on equity (ROE)= Net income/ Equity
= $763/ $5,236
=14.5722%
Retention Ratio =1-dividend payout ratio
= 1-0.34 = 0.66
Internal growth rate = ROE× Retention ratio
=14.5722%×0.66
=9.62%
Hence the internal growth rate = 9.62%
2) Calculation of sustainable growth rate :-
We have the following formula
Sustainable growth rate = Retention ratio*ROE/(1-ROE*Retention ratio)
Where,
Retention Ratio =1-dividend payout ratio
= 1-0.22 = 0.88
Return on equity (ROE)= Net income/ Equity
=4,420/26180
=16.88%
Substituting the values we get,
Sustainable growth rate= (0.88×0.1688)/(1-0.88×0.1688)
=0.148544/0.851456
=17.45%
Hence the sustainable growth rate = 17.45%
3) Calculation of maximum increase in sales that can be sustained assuming no new equity is issued
Sustainable growth rate = Retention ratio*ROE/(1-ROE*Retention ratio)
Where,
Retention Ratio =1-dividend payout ratio
= 1-0.40 = 0.60
Return on equity (ROE)= Net income/ Equity
=10,530/60,750
=17.33%
Substituting the values we get,
Sustainable growth rate= (0.60×0.1733)/(1-0.60×0.1733)
=0.10398/0.89602
=11.60%
Maximum increase in sales= Sustainable growth rate ×Existing sales
=11.60%×45000
=$5,220.
Hence the maximum increase in sales = $5,220.
4) Calculation of internal growth rate
Internal growth rate = (ROA×b)/(1-ROA×b)
Where
ROA= 12% (given)
b=dividend retention ratio = 1- payout ratio
=1-0.21= 0.79
Substituting the values
Internal growth rate = (0.12×0.79)/(1-0.12×0.79)
=0.0948/0.9052
=10.47%
Hence the internal growth rate = 10.47%
Please feel free to ask if you have any query in the comment section.
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