Question

You've collected the following information about Oscar & Ollie Inc.:

Sales = $165,000

Net Income = $14,800

Dividends = $9,300

Total Debt = $68,000

Total Equity = $51,000

What is the sustainable growth rate? If it does grow at this rate, how much new borrowing will take place in the coming year, assuming a constant debt–equity ratio? What growth rate could be supported with no outside financing at all?

Answer 1

Sustainable growth rate= Retention rate*return on equity

Rentention rate= [(net income-dividends)/net income]
=[($14,800-$9,300)/$14,800]
=[($5,500)/$14,800]
= 37.16%

Return on equity= Net income/Total shareholders equity
=$14,800/$51,000
=29.02%

Sustainable growth rate= 37.16%*29.02%
Sustainable growth rate= 10.78%

New Borrowing

Total New Asset= [(1+Sustainable growth rate)*(Total debt+Total Equity)]
=  [(1+10.78%)*($68,000+$51,000)]
=[(1.1078)*($119,000)]
= $131,828.20

Total New debt= [Total New Asset*(Total debt/total debt+total equity)]
=[$131,828.20*($68,000/$68000+$51,000)]
=[$131,828.20*0.57]
=$75,330.40

The growth rate that can be supported with no outside financing is the internal growth rate.
Calculation of ROA= $14,800/$68000+$51000
= $14,800/$119,000
= 12.44%

Internal growth rate= (ROA*b)/[1-(ROA*b)]
b= retrntion rate
37.16%= 0.3716
(0.1244*0.3716)/[1-(0.1244*0.3716)]
(0.046/0.954)
0.0485
= 4.85%