The business of Company is booming and its sales went up by 30 % this year. The

Question

The business of Company is booming and its sales went up by 30 % this year. The same sales growth rate could continue next year if the company is able to expand its capacity in equal proportion to the sales. The firm currently has assets worth €4 million, €1 million in debt, a return on equity of 25 % and a dividend payout ratio of 50 %.

a) What is Company’s internal growth rate if it holds its dividend payout ratio constant?
b) What is Company’s sustainable growth rate?
c) Calculate Company’s required external funds next year if the company wishes to grow
by 30 % and hold its dividend payout ratio constant.

Explanation / Answer

a)Internal growth rate= (ROA*b)(1-ROA*b) Here ROE =25% ROE Standard formula =net income /share holders equity 25%=Net income/ 3 Since total assets =$4mill, debt =$1mill, therefore equity=$4-$1=$3mill Net income=3*25% =$.75 million ROA=Net income/ Total assets =$.75 million/ $4 mill =18.75% Internal growth rate= (ROA*b) (1-ROA*b) (Since b=1-payout ratio=1-0.5=0.5) = (.1875*.5) (1-.1875*.5) =8.5% b) Sustainable growth rate= (ROE*b) (1- ROE*b) = (0.25*0.5) (1-0.25*0.5) =10.94% c) If company grow by 30% then required external funds: = (Asset /sales)*(changes in sales)-((debt/changes in sales) - (profit margin ratio*projected sales)*((1-dividend payout ratio)) =(4/1)(.3)-((1/.3)-((0.75/1)(0.3))*(1-0.5)) =2.02million needed Note: Here sale has been assumed 100%=1, and Changes in sales =100%-130% =30% =.3

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