Question

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

INCOME STATEMENT				BALANCE SHEET
Sales	$	76,700		Current assets	$	22,000		Long-term debt	$	56,000
Costs		61,000		Fixed assets		150,000		Equity		116,000
Taxable income	$	15,700		Total	$	172,000		Total	$	172,000
Taxes (24%)		3,768
Net income	$	11,932

Assets and costs are proportional to sales. The company maintains a constant 40 percent dividend payout ratio and a constant debt-equity ratio.

What is the maximum increase in sales that can be sustained assuming no new equity is issued? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Solution:

   Step 1: We need to calculate Return on Equity (ROE)

Return on equity (ROE) = (Net Income / Equity )*100

Return on equity (ROE) = ( $ 11,932 / $ 1,16,000)*100

Return on equity (ROE) = 10.28%

   Step 2: Calculation of Sustainable growth rate

Computation of retention or retaining ratio :

Payout ratio = 0.40

Retention or Retaining ratio = 1 - Payout ratio

Retention ratio is denoted as “ b”

b = 1 – payout ratio

b = 1 – 0.40

b = 0.60

Computation of sustainable growth rate is shown below:

Growth rate = b *return on equity (ROE) / [ 1 – ( Return on equity (ROE) *b)]

Growth rate = 0.60 * 10.28 % / [ 1- (10.28%*0.60)]

Growth rate = 0.06168 / 5.168

Growth rate = 0.01193

Step 3 : Maximum increase in sales without no equity issuance :

= Sustainable growth rate *Recent sales value

= 0.01193 * Sales value

= 0.01193 * $ 76,700

= $ 915.03

Maximum increase in sales without no equity issuance = $ 915.03

Thank you !!!!!