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):

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.


Now Fill in the following chart:

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

b. What negatives might be associated with fixing the problems revealed by the analysis?

Explanation / Answer

For Baxter, the ratios are as follows: Retention ratio = 1 - Dividends/Earnings after tax = 1 - 700/1000 = 30% return on sales = Earnings after tax / Sales = 1000 / 20,000 = 5% Asset turnover = Sales / total assets = 1000 / 10000 = 0.1 Equity multiplier = Total assets / total equity = 10,000 / 8000 = 1.25 As compared to industry average, Baxter has a lower retention ratio of 30% compared to industry average of 90%, lower asset turnover of 0.1 compared to industry average of 1.9 and lower equity multiplier of 1.25 compared to industry average of 3. These lower ratios are causing Baxter to grow at a slower rate compared to its competitors in the industry despite having a higher return on sales of 5% compared to industry average of 4%. If Baxter tries to fix these problems, it will take on a higher financial and operational leverage, thereby increasing the risk to the firm.

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