Question

Chapter 4 Problem 11
Problem 15, part f. in Chapter 3 asks you to construct a five year financial projection for Aquatic Supplies beginning in 2015.
The five year projection appears below.
a. Calculate Aquatic Supplies's sustainable and actual growth rates in these years.
b. What do these numbers suggest to you?
	Aquatic Supplies Co. Five Year Projected Income Statements and Balance Sheets
			Income Statement (in $ millions)
			Pro Forma Forecasts 2015 - 2019
	2014	Assumptions	2015	2016	2017	2018	2019
Sales	$      582.762	12%	652.693	731.017	818.739	916.987	1,027.026
Cost of Goods Sold	240.828	39%	254.550	285.096	319.308	357.625	400.540
Gross Profit	341.934		398.143	445.920	499.431	559.362	626.486
Selling, General, & Administrative Exp.	257.507	49%	319.820	358.198	401.182	449.324	503.243
Operating Income Before Deprec.	84.427		78.323	87.722	98.249	110.038	123.243
Depreciation, Depletion, & Amortization	25.221	30%	29.371	32.896	36.843	41.264	46.216
Operating Profit	59.206		48.952	54.826	61.405	68.774	77.027
Interest Expense	16.430	initially constant	18.636	18.801	18.841	18.733	18.446
Pretax Income	42.776		30.316	36.025	42.564	50.041	58.581
Total Income Taxes	14.971	35%	10.611	12.609	14.897	17.514	20.503
Net income	$        27.805		$        19.705	$        23.416	$      27.667	$      32.527	$      38.078
			Balance Sheet (in $ millions)
ASSETS
Cash & Equivalents	$         7.152	2%	13.054	14.620	16.375	18.340	20.541
Account Receivable	70.538	13%	84.850	95.032	106.436	119.208	133.513
Inventories	39.033	5%	32.635	36.551	40.937	45.849	51.351
Prepaid Expenses	9.339	no change	9.339	9.339	9.339	9.339	9.339
Other Current Assets	27.076	6%	39.162	43.861	49.124	55.019	61.622
Total Current Assets	153.138		179.039	199.403	222.211	247.756	276.366
Net Plant, Property & Equipment	81.648	15%	97.904	109.652	122.811	137.548	154.054
Intangibles	9.415	no change	9.415	9.415	9.415	9.415	9.415
Other Assets	24.642	5%	32.635	36.551	40.937	45.849	51.351
TOTAL ASSETS	$      268.843		318.993	355.022	395.374	440.568	491.186
LIABILITIES
Accounts Payable	$        36.951	6%	39.162	43.861	49.124	55.019	61.622
Accrued Expenses	31.206	5%	32.635	36.551	40.937	45.849	51.351
Other Current Liabilities	3.663	no change	3.663	3.663	3.663	3.663	3.663
Total Current Liabilities	71.820		75.459	84.075	93.724	104.532	116.636
Long Term Debt	157.720	initially constant	186.363	188.010	188.414	187.327	184.462
Accrued wages	21.418	3%	19.581	21.930	24.562	27.510	30.811
Total Liabilities	250.958		281.403	294.015	306.701	319.368	331.908
EQUITY
Common Stock	1.702	no change	1.702	1.702	1.702	1.702	1.702
Capital Surplus	55.513	no change	55.513	55.513	55.513	55.513	55.513
Retained Earnings	118.729	no dividends paid so all income is retained	138.434	161.851	189.517	222.044	260.122
Less: Treasury Stock	158.059	no change	158.059	158.059	158.059	158.059	158.059
TOTAL EQUITY	17.885		37.590	61.007	88.673	121.200	159.278
TOTAL LIABILITIES & EQUITY	$      268.843		$       318.993	$       355.022	$     395.374	$     440.568	$    491.186

Answer 1

a. Sustainable grwth rate = Retention ratio * ROE

Retrun on Equity (ROE) = net income/ total equity

Since the dividend payment is not given on any year, we assume that all of the net income was retained and hence retention ratio = 1 or 100%

The sustainable and actual growth rates are as shown below:

Year	Net Income (in Millions)	Total equity (in millions)	ROE	Retention Ratio	Sustainable growth rate	Actual growth rate
2015	19.705	37.59	52.42%	1	52.42%	0
2016	23.416	61.007	38.38%	1	38.38%	18.83%
2017	27.667	88.673	31.20%	1	31.20%	18.15%
2018	32.527	121.2	26.84%	1	26.84%	17.57%
2019	38.078	159.278	23.91%	1	23.91%	17.07%

The excel screen shot is as shown below:

(b) Looking at the sustainable and actual growth rate, we can see that the business still has some room to grow. This is because the sustainable growth rate is higher than the actual growth rate. So the company can either use the retained earnings to grow faster or reduce the retained earnings by giving away some of the net income as dividend to the shareholders. (We have 0 as the actual growth rate for 2015 since from 2014 to 15% there was actual de growth. We have considered this to be extraordinary and not considered it)