Baxter Inc. is in a fast growing industry, but doesn\'t seem to be able to match

Question

Baxter Inc. is in a fast growing industry, but doesn't seem to be able to match its competitors' growth rates. Selected financial information for Baxter is as follows ($000):
Baxter

Sales: $20,000
EAT: $ 1,000
Total Assets: $10,000
Equity: $ 8,000
Annual dividend: $ 700


Research has revealed that the average firm in Baxter's industry pays out 10% of its earnings in dividends, earns 4 cents after tax on every sales dollar, has an equity multiplier of 3.0 and a total asset turnover of 1.9.

a.

Use a sustainable growth rate analysis in the following table to determine the source(s) of Baxter's growth problems. Please provide numbers for Baxter and Industry, separately





               gs =    Retention Ratio     Return on Sales     Total Asset Turnover       Equity Multiplier
Industry

Baxter

Explanation / Answer

Equity Multiplier = 3.0
Total Asset Turnover = 1.9
Profit Margin = [Net Income / Sales]= [$1,000 / $20,000]= 0.05

Sustainable growth rate: The maximum possible growth rate for a firm that maintains a constant debt ratio and doesn’t sell new stock.

Sustainable growth rate = [(ROE x b) / (1-ROE x b)]
ROE = Profit Margin x Total Asset Turnoverx Equity multiplier

b = Plowback (retention) ratio
= Addition to retained earnings / Net Income
= 1 – Dividend payout ratio

Dividend payout ratio = 10%
Plowback (retention) ratio (b) = 1 – 0.10= 0.9


ROE = 0.05 x 1.9x 3.0 = 0.285 = 28.5%

Sustainable growth rate = [(0.285 x 0.9) / (1-0.285x 0.9)]
= [0.2565 / (0.715 * 0.9)]= = [0.2565 / 0.6435]== 0.3986 (or) 39.86%

Sustainable growth rate = 39.86%

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