Question
In: Finance
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?
Solutions
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% | |||||||||
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