Question

The most recent financial statements for Drennan Manufacturing Co. are shown below:

Income Statement			Balance Sheet
Sales	$	75,300	Current assets	$	27,000	Debt	$	37,200
Costs		55,380	Fixed assets		89,300	Equity		79,100
Taxable income	$	19,920	Total	$	116,300	Total	$	116,300
Tax (40%)		7,968
Net Income	$	11,952

Assets and costs are proportional to sales. Debt and equity are not. The company maintains a constant 25 percent dividend payout ratio. No external financing is possible.

Required:

What is the internal growth rate? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Internal growth rate

%

The most recent financial statements for Drennan Manufacturing Co. are shown below:

Income Statement			Balance Sheet
Sales	$	75,300	Current assets	$	27,000	Debt	$	37,200
Costs		55,380	Fixed assets		89,300	Equity		79,100
Taxable income	$	19,920	Total	$	116,300	Total	$	116,300
Tax (40%)		7,968
Net Income	$	11,952

Assets and costs are proportional to sales. Debt and equity are not. The company maintains a constant 25 percent dividend payout ratio. No external equity financing is possible.

Required:

What is the sustainable growth rate? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Sustainable growth rate

%

Answer 1

Answer to Question 1:

Return on Assets = Net Income / Total Assets
Return on Assets = $11,952 / $116,300
Return on Assets = 0.10277 or 10.277%

Retention Ratio = 1 - Payout Ratio
Retention Ratio = 1 - 0.25
Retention Ratio = 0.75

Internal Growth Rate = [Return on Assets * Retention Ratio] / [1 - Return on Assets * Retention Ratio]
Internal Growth Rate = [0.10277 * 0.75] / [1 - 0.10277 * 0.75]
Internal Growth Rate = 0.077078 / 0.922922
Internal Growth Rate = 0.0835 or 8.35%

Answer to Question 2:

Return on Equity = Net Income / Total Equity
Return on Equity = $11,952 / $79,100
Return on Equity = 0.15110 or 15.110%

Retention Ratio = 1 - Payout Ratio
Retention Ratio = 1 - 0.25
Retention Ratio = 0.75

Sustainable Growth Rate = [Return on Equity * Retention Ratio] / [1 - Return on Equity * Retention Ratio]
Sustainable Growth Rate = [0.15110 * 0.75] / [1 - 0.15110 * 0.75]
Sustainable Growth Rate = 0.113325 / 0.886675
Sustainable Growth Rate = 0.1278 or 12.78%