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Gadgets Inc. has the following information. Compare the spread between actual and sustainable growth for 1998...

Gadgets Inc. has the following information. Compare the spread between actual and sustainable growth for 1998 with the spread for 2001 only, what is the main reason for the change in spread? Compare the components of the sustainable growth rate for the two years to see how each has contributed to the decrease/increase in sustainable growth

Gadgets ($ in millions)
	1996	1997	1998	1999	2000	2001
Sales		$ 128.40	$ 171.60	$ 208.20	$ 241.60	$ 288.40
Net income		8.00	8.30	0.40	6.10	12.80
Total assets		64.70	84.30	86.40	96.70	118.80
Equity	30.80	49.10	58.50	60.00	66.10	79.40
Dividends		-	-	-	-	-

Expert Solution

Calculating Sunstanable growth rate & Actual rate for yr 1998 & 2001

Sustainable growth rate = Return on equity(ROE)*Bussiness Retention ratio

Where, Return on equity(ROE) = Asset utilization rate * Profitability rate * Financial Utilization rate

&, Asset utilization rate = Total sales throughout the yr / Total Asset

&, Profitability rate =Net Income/Total Sales throughout the yr

& Financial Utilization rate =Total Debt / Total equity

& Actual growth rate=Sales Figure from starting point -Most recent sales figure/Sales Figure from starting point

Thus, for 1998 2001

Profitabilty rate 8.3/171.6= 4.83% 12.8/288.4=4.43%

Asset utilization rate 171.6/84.3=203.55% 288.4/118.8=242.76%

Total Debt 84.3-49.1=35.2% 118.8-79.4 =39.4%

Financial Utilization rate 35.2/58.5=60.2% 39.4/79.4=49.62%

ROE 4.83%*203.55%*60.2%=5.91% 4.43%*242.76%*49.62%=5.34%

Dividend rate =0% =0%

Bussiness retention rate =100% =100%

Sustanable growth rate 5.91%*100%=5.91% 5.34%

Actual Growth rate (171.6-128.4)/128.4=33.6% =22.4%

using formula Present= Past(1+growth rate)ⁿ

For 2001, 288.4= 128.4(1+g)⁴ , g=22.4%

Spread is the diff. between the actual & sustainable growth rate

For 1998= Actual-sustainable=33.6%-5.91%=27.69%

For 2001= Actual-sustainable=22.4%-5.34%=17.06%

Reason for the change in spread is changing demand of product.

Component of Sustainable growth rate are Profitaibilty rate,Asset utilization rate & Financial Utilization rate which are described above.

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