Question

You’ve collected the following information about Erna, Inc.: Sales = $ 320,000 Net income = $ 18,500 Dividends = $ 7,300 Total debt = $ 68,000 Total equity = $ 99,000 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.) Growth rate %

Answer 1

a)	Sustainable growth rate [SGR] = is given by the formula = ROE*b/(1-ROE*b)
	where, ROE= Return on equity and b = retention ratio.
	ROE = Net income/Equity = 18500/99000 =	18.69%
	b (retention ratio)= (NI-Dividends)/NI = (18500-7300)/18500 =	60.54%
	Now SGR = 0.1869*0.6054/(1-0.1869*0.6054)=	12.76%
b)	If the above growth rate is to be made the new total assets will be:
	= (68000+99000)*1.1276 =	$   1,88,309.20
	Total debt at the present capital structure = 188309.20*68000/(68000+99000) =	$       76,676.80
	Existing debt	$       68,000.00
	New borrowing to take place in the coming year	$         8,676.80
c)	Growth rate to be supported without additional external financing [IGR] = ROA*b/(1-ROA*b).
	where ROA = Return on total assets and b = retention ratio.
	ROA = 18500/(68000+99000) =	11.08%
	IGR = 0.1108*0.6054/(1-0.1108*0.6054) =	7.19%