Firm UUU earns $0.2 in profit on every $1 of sales, has $0.5 in assets for...

Firm UUU earns $0.2 in profit on every $1 of sales, has $0.5 in assets for every $1 of sales and for has $2 debt on every $1 equity. The firm pays out 20 percent of its profits to its shareholders. What is the internal growth rate? What is the sustainable growth rate?

Expert Solution

Assume Total sales =			$1

Profit is 0.2 on $1 sales =			$0.2

Assets 0.5 for $1 sales =			$0.5

Debt equity ratio = $2 for $1 equity

Debt + Equity = Total assets =			$0.5

So, Equity = 0.5 * 1/3 =			$0.16667		0.166667

Payout ratio =		20% or	0.2
So, Retention ratio = 80% or			0.8

(a) Calculation of Internal growth rate

Internal growth rate is maximum growth rate that firm can achieve without use of external financing.

Internal Growth rate formula =				*Return on Assets Retention ratio**
				_______________________________
				*1 - (Return on assets Retention ratio)**

Return on assets = Profit (Net income ) / Assets

	0.2 / 0.5
	0.4

Internal growth rate =			( 0.4 * 0.8 )
			__________
			1 - (0.4 * 0.8)

	0.470588	or 47.06%

So, Internal growth rate is 47.06%


(b) Calculation of Sustainable growth rate

*Sustainable Growth rate = Return on Equity Retention ratio.**

Return on equity = Profit ( Net income ) / Equity

	0.2 / 0.16667
	1.2

Sustainable growth rate = 1.2 * 0.80

	0.96	or 96%

So, Firm's sustainable growth rate is 96%

jeff jeffy answered 1 year ago

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