4. A firm had equity of $225,000 at the beginning of the year. At the end of the

Question

4. A firm had equity of $225,000 at the beginning of the year. At the end of the year, the company had total assets of $310,000. During the year the company sold no new equity. Net income for the year was $12,000 and dividends were $2,250.

a. What is the substantial growth rate for the company?

b. What is the substantial growth rate if you use the formula ROE x b and beginnng of period equity?

c. What is the substantial growth rate if you use end of period equity in this formula?

d. Is this number too high or too low? Why

Explanation / Answer

Substantial Growth rate = ROEx(1-Dividend payout ratio)

ROE = Net Income/Shareholders Equity

ROE = 12000/225000 = 5.33%

Dividend Payout ratio = Dividend /Net Income

Dividend Payout ratio = 2250/12000 =18.75%

Substantial Growth rate = ROEx(1-Dividend payout ratio)

Substantial Growth rate = 5.33%x(1-18.75%)

Substantial Growth rate = 0.0533x0.8125

Substantial Growth rate  = 0.0433 or 4.33%

c) The End of period equity will be

equity at the Beginning of the Period +Net income - Dividend = 225000+12000-2250 = $234750

ROE = Net Income/Shareholders Equity

ROE = 12000/234750 = 5.11%

Dividend Payout ratio = Dividend /Net Income

Dividend Payout ratio = 2250/12000 =18.75%

Substantial Growth rate = ROEx(1-Dividend payout ratio)

Substantial Growth rate = 5.11%x(1-18.75%)

Substantial Growth rate = 0.0511x0.8125

Substantial Growth rate = 4.15%

d) This Number is too low because it means that a company can grow at only 4.15% using its own resources and to grow at a faster pace , it will have to borrow from outside sources to grow beyond 4 and a half percent.

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