Question

You’ve collected the following information about Odyssey, Inc.:

Sales		$	249808
Net income		$	12751
Dividends		$	3262
Total debt		$	94760
Total equity		$	63488

If the company grows at the sustainable growth rate, how much new borrowing will take place in the coming year, assuming a constant debt–equity ratio?

(Omit the "$" sign and commas in your response. Enter your answer rounded to 2 decimal places. For example, $1,200.456 should be entered as 1200.46.)

Answer 1

Computation of Sustainable growth rate

Sustainable growth rate = (ROE * 1- dividend payout ratio) / [ 1-(ROE (1- dividend payout ratio))]

ROE = Net income / Total equity

= $12751 / $63488

= 0.2008 or 20.08%

Dividend payout ratio = Dividends / Net income

= $3262 / $12751

= 0.2558 or 25.58%

Sustainable growth rate = 0.2008 *(1-0.2558) / [1-(0.2008(1-0.2558))]

= 0.1757 or 17.57%.

If the company grows at the sustainable growth rate, the new level of total assets is:New TA = 1.1757($158,248) = $186,052.17

To find the new level of debt in the company’s balance sheet, we take the percentage of debt in the capital structure times the new level of total assets. The additional borrowing will be the new level of debt minus the current level of debt. So:

New TD = [D / (D + E)](TA)

New TD = [$94,760 / ($94,760 + 63,488)]($186,052.17)

New TD = $111,409.33

And the additional borrowing will be:

Additional borrowing = $111,409.33– 94,760

Additional borrowing = $16,649.33