Question

5. The following is adapted from Financial Management for Executives (2nd ed.): Procter and Gamble (P&G) reports the following information in a recent financial statement (the figures represent millions except for Earnings per share and Dividends per share). Use the below information to compute P&G’s sustainable growth rate for Years 2 and 3 and comment on P&G’s sustainable growth rate relative to its actual rate of growth.

	Year 1	Year 2	Year 3
Sales	$56,741	$68,222	$83,503
Net income	8,684	10,340	12,075
Shareholders’ equity	62,908	66,760	69,494
Earnings per share	2.79	3.22	3.86
Dividends per share	1.15	1.28	1.45

Answer 1

Sustainable growth rate (SSGR) = Return on equity * (1- dividend payout ratio)

Basically,SSGR is the growth rate that you can expect a firm to grow without additional financing

Units in $

For year 1:

Return on equity = net income / equity = 8684/62908 = 13.80%

Dividend payout ratio = Dividend per share / earnings per share = 1.15/2.79=0.41

Sustainable growth rate = Return on equity * (1- dividend payout ratio) = 13.80% * (1-0.41) = 8.14%

This is the sustainable rate of growth that you can expect in the next year ( year 2) . But actual growth rate in net income is

(10,340 - 8684)/8684 = 19.07% which is far higher than the SSGR.

For year 2:

Return on equity = net income / equity = 10340/66760 = 15.49%

Dividend payout ratio = Dividend per share / earnings per share = 1.28/3.22=0.40

Sustainable growth rate = Return on equity * (1- dividend payout ratio) = 15.49% * (1-0.40) = 9.29%

This is the sustainable rate of growth that you can expect in the next year ( year 2) . But actual growth rate in net income is

(12075-10,340)/10340 = 16.78% which is far higher than the SSGR.