Maggie\'s Muffins, Inc., generated $4,000,000 in sales during 2015, and its year

Question

Maggie's Muffins, Inc., generated $4,000,000 in sales during 2015, and its year-end total assets were $2,600,000. Also, at year-end 2015, current liabilities were $1,000,000, consisting of $300,000 of notes payable, $500,000 of accounts payable, and $200,000 of accruals. Looking ahead to 2016, the company estimates that its assets must increase at the same rate as sales, its spontaneous liabilities will increase at the same rate as sales, its profit margin will be 5%, and its payout ratio will be 55%. How large a sales increase can the company achieve without having to raise funds externally; that is, what is its self-supporting growth rate? Do not round intermediate steps. Round your answers to the nearest whole.

Sales can increase by $ ____, that is by _____%.

Explanation / Answer

Self-supporting growth rate is also known as sustainable growth rate. We have the following formula for sustainable growth rate:

Sustainable growth rate = ROE x( 1- Dividend payout ratio)

We first need to compute Return on Equity.

Profit = Sales x profit margin ratio

                = 4,000,000x5%

                = 200,000

Shareholder’s equity = Assets – Liabilities

                                         =2,600,000-1,000,000

                                         = 1,600,000

ROE = profit/ Shareholder’s equity

                = 200,000/ 1,600,000

                = 12.50%

Dividend payout ratio = 55%

Plugging the values in sustainable growth rate formula, we get:

Sustainable growth rate = 12.50% x( 1-0.55)

                                                = 5.625%

Sales can increase by 5.625%,

Increase in sales in dollars = 4,000,000 x 5.625%

=225,000

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