Question

The most recent financial statements for Bello Co. are shown here:

Income Statement				Balance Sheet
Sales	$	19,800		Current assets	$	11,880		Debt	$	16,240
Costs		13,500		Fixed assets		30,150		Equity		25,790
Taxable income	$	6,300		Total	$	42,030		Total	$	42,030
Taxes (24%)		1,512
Net income	$	4,788

Assets and costs are proportional to sales. Debt and equity are not. The company maintains a constant 35 percent dividend payout ratio.

What is the internal growth rate?

Answer 1

Solution:

The Internal growth rate is calculated using the following formula

Internal growth rate = ( ROA * b ) / (1- (ROA *b) )

Where ROA = Return on Assets = (Net Income / Total Assets)

b = Retention ratio = ( 1 – Dividend Payout Ratio )

Calculation of ROA:

As per the information given in the question we have

Net Income = $ 4,788   ; Total Assets = $ 42,030

Applying these values in the ROA formula above we have

Return on assets = ( $ 4,788 / $ 42,030 ) = 0.1139

Calculation of Retention ratio :

As per the information given in the question we have

Dividend Payout Ratio = 0.35

Applying these values in the Retention ration formula above we have

Retention ratio = 1 – 0.35 = 0.65

Calculation of Internal Growth Rate:

Internal growth rate = [                 ( ROA * b ) / (1- (ROA *b) ) ]

Where ROA = 0.1139 & b = 0.65

Applying these values in the formula we have

= ( 0.1139 * 0.65 ) / ( 1 – (0.1139 * 0.65 )

= 0.0740 / ( 1 – 0.0740 ) = 0.0740/ 0.9260 = 0.0800

= 8 %

Thus Internal growth rate of Bella Co. = 8 %