****I ONLY NEED THE SECOND PART OF THIS QUESTION ANSWERED (PART B)**** A. Abbrev
ID: 2670428 • Letter: #
Question
****I ONLY NEED THE SECOND PART OF THIS QUESTION ANSWERED (PART B)****
A. Abbreviated financial Statements for Archimedes Levers are shown in the following table. If sales increase by 10% in 2011 and all other items, including debt, increase correspondingly, what must be the balancing item? What will be its value?
B. What is the maximum possible growth rate for Archimedes if the payout ratio is set at 50% and (a) no external debt or equity is to be issued? (b) the firm maintains a fixed debt ratio but issues no equity?
INCOME STATEMENT
Sales
$4000
Costs, including interest
3,500
Net income
$500
BALANCE SHEET, YEAR END
2010
2009
2010
2009
Assets
$3200
$2700
Debt
$1200
$1033
-
-
-
Equity
2,000
1,667
Total
$3200
$2700
Total
$3200
$2700
INCOME STATEMENT
Sales
$4000
Costs, including interest
3,500
Net income
$500
BALANCE SHEET, YEAR END
2010
2009
2010
2009
Assets
$3200
$2700
Debt
$1200
$1033
-
-
-
Equity
2,000
1,667
Total
$3200
$2700
Total
$3200
$2700
Explanation / Answer
Part-B
a) When the firm issues no external debt or equity:
Payout ratio = 50%
Retention ratio is calculated as (1 - payout ratio)
Retention ratio = 1 - Payout ratio
= 1 - 50%
= 50%
Here we have to calculate the internal growth rate.
Internal growth rate = [ROA * b] / [1-(ROA * b)]
Calculating the ROA ratio for 2010:
ROA = Net income / Total assets
= $500 / $3,200
= 0.15625 or 15.625%
Retention ratio is denoted with "b"
Substituting the values int he Internal growth rate formula, we get
Internal growth rate = [0.15625 * 0.50] / [1-(0.15625 * 0.50]
= 0.078 / 0.922
= 0.0846 or 8.46%
Therefore, the internal growth rate is 8.46%
When the
b) When the firm maintains a fixed debt ratio but issues no equity.
Here we have to calculate the Sustainable growth rate.
Sustainable growth rate = [ROE * b] / [1-(ROE * b)]
Calculating the ROE for 2010:
ROE = Net income / Total equity
= $500 / $2,000
= 0.25 or 25%
Substituting the values int he Sustainable growth rate formula, we get
Sustainable growth rate = [ROE * b] / [1-(ROE * b)]
= [0.25 * 0.50] / [1-(0.25 * 0.50)]
= 0.125 / (1 -0.125)
= 0.125 / 0.875
= 0.143 or 14.3%
Therefore, the sustainable growth rate is 14.3%
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