Question

As a firm grows, it must support increases in revenue with new investments in assets. The self-supporting, or sustainable, growth model helps a firm assess how rapidly it can grow, while maintaining a balance between its cash outflows (increases in noncash assets) and inflows (funds resulting from increases in liabilities or equity).

Consider the following case of Green Caterpillar Garden Supplies Inc.:

Green Caterpillar Garden Supplies Inc. has no debt in its capital structure and has $300,000,000 in assets. Its sales revenues last year were $180,000,000 with a net income of $6,000,000. The company distributed $190,000 as dividends to its shareholders last year.

Given the information above, what is Green Caterpillar Garden Supplies Inc.’s sustainable growth rate?

0.0633755%

3.9036694%

1.97%

0.6026989%

Which of the following are assumptions of the sustainable (self-supporting) growth model? Check all that apply.

A. The firm pays out a constant proportion of its earnings as dividends.

B. The firm’s total asset turnover ratio remains constant.

C. The firm’s liabilities and equity must increase at the same rate.

D. The firm pays no dividends.

Answer 1

Return on equity= Net Income/Equity*100

=6000000/300000000*100

=2%

Payout Ratio= Dividend Paid/Net Income

=190000/6000000

= 0.03166667

Retention Ratio= 1 - Payout ratio

= 1-0.3166667

=0.968333

Sustainable Growth Rate= ROE *Retention Ratio/ (1- ROE *Retention Ratio)

= 0.02* 0.96833/(1- 0.02*0.96833)

= 1.97%

Assumption of sustainable growth model are:-

1)The firm pays out constant proportion of its earning as dividend.

2)The firm's total asset turnover ratio remains constant

Only above two assumption are followed.