4. Sustainable growth Aa Aa As a firm grows, it must support increases in revenu

Question

4. Sustainable growth Aa Aa As a firm grows, it must support increases in revenue with new investments in assets. The self-supporting growth model helps a firm assess how rapidly it can grow, while maintaining a balance between its cash outflows (increases in noncash assets) and inflows (funds resulting from increases in liabilities or equity) Consider this case: Cold Duck Manufacturing Inc. has no debt in its capital structure and has $300 million in assets. Its sales revenues last year were $180 million with a net income of $10 million. The company distributed $1.10 mion as dividends to its shareholders last year. What is the firm's self-supporting growth rate? O 3.06% 3.85% 0 0.90% 0.37% Which of the following are assumptions of the self-supporting growth model? Check all that apply. The firm's total asset turnover ratio remains constant. The firm pays out a constant proportion of its earnings as dividends The firm will not issue any new common stock next year. The firm pays no dividends.

Explanation / Answer

1) Calculation of self supporting growth rate

Self supporting growth rate = ROE* Retention Ratio /(1- (ROE* Retention Ratio))

ROE = (Net income/Shareholders Equity)

= 10 million/300 million

= 0.03333333333

= 3.333333333%

Retention Ratio = 1- Payout Ratio

= 1-(Amount distributed/Net income)

= 1-(1.10 million/10 million)

= 1-.11

= .89

Self supporting growth rate =.03333333333* .89/(1- (3.333333333* .89))

= 0.02966666666/1-0.02966666666

= 0.02966666666/0.97033333334

= 0.03057368601

= 3.06%

2) Assumptions in self supporting growth Model

The major assumptions in self supporting growth Model are

So select option 1 (as Constant Asset to sales ratio), option 2 ( as Company maintains its current dividend payout policy.) and option 3 (as company maintains its current capital structure)

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