Question

You’ve collected the following information about Erna, Inc.:

Sales	=	$	250,000
Net income	=	$	17,100
Dividends	=	$	5,900
Total debt	=	$	54,000
Total equity	=	$	85,000

What is the sustainable growth rate for the company? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Sustainable growth rate             %
  
Assuming it grows at this rate, how much new borrowing will take place in the coming year, assuming a constant debt–equity ratio? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
  
Additional borrowing            $
  
What growth rate could be supported with no outside financing at all? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  

Answer 1

Return on Equity, ROE = Net Income / Total Equity
Return on Equity, ROE = $17,100 / $85,000
Return on Equity, ROE = 0.20118 or 20.118%

Retention Ratio, b = (Net Income - Dividends) / Net Income
Retention Ratio, b = ($17,100 - $5,900) / $17,100
Retention Ratio, b = 0.6550

Total Assets = Total Debt + Total Equity
Total Assets = $54,000 + $85,000
Total Assets = $139,000

Return on Assets, ROA = Net Income / Total Assets
Return on Assets, ROA = $17,100 / $139,000
Return on Assets, ROA = 0.12302 or 12.302%

Debt Ratio = Total Debt / Total Assets
Debt Ratio = $54,000 / $139,000
Debt Ratio = 0.3885

Answer a.

Sustainable Growth Rate = [ROE * b] / [1 - ROE * b]
Sustainable Growth Rate = [0.20118 * 0.6550] / [1 - 0.20118 * 0.6550]
Sustainable Growth Rate = 0.1317729 / 0.8682271
Sustainable Growth Rate = 0.1518 or 15.18%

Answer b.

Total Assets, Current Year = Total Assets, Previous Year * (1 + Growth Rate)
Total Assets, Current Year = $139,000 * 1.1518
Total Assets, Current Year = $160,100.20

Total Debt, Current Year = Total Assets, Current Year * Debt Ratio
Total Debt, Current Year = $160,100.20 * 0.3885
Total Debt, Current Year = $62,198.93

Additional Borrowing = Total Debt, Current Year - Total Debt, Previous Year
Additional Borrowing = $62,198.93 - $54,000.00
Additional Borrowing = $8,198.93

Answer c.

Internal Growth Rate = [ROA * b] / [1 - ROA * b]
Internal Growth Rate = [0.12302 * 0.6550] / [1 - 0.12302 * 0.6550]
Internal Growth Rate = 0.0805781 / 0.9194219
Internal Growth Rate = 0.0876 or 8.76%