Question

5. Sustainable growth Aa Aa E 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 Cold Duck Manufacturing Inc.: Cold Duck Manufacturing Inc. has no debt in its capital structure and has $150,000,000 in assets. Its sales revenues last year were $45,000,000 with a net income of $1,500,000. The company distributed $120,000 as dividends to its shareholders last year. Given the information above, what is Cold Duck Manufacturing Inc.'s sustainable growth rate? O 1.14% 01.09% O 0.93% 0.08% Which of the following are assumptions of the sustainable (self-supporting) growth model? Check all that apply. Common stock is the firm's only form of equity. The firm maintains a constant net profit margin. The firm's liabilities and equity must increase at the same rate. The firm maintains a constant ratio of assets to equity.

Answer 1

a). ROE = Net income / Equity = $1,500,000 / $150,000,000 = 0.01, or 1%

Dividend Rate = Dividend / Net Income = $120,000 / $1,500,000 = 0.08, or 8.00%

Retention ratio = (1 - Dividend rate) = 1 - 0.08 = 0.92, or 92.00%

Sustainable growth rate = [ROE * Earnings retention ratio] / [1 - (ROE * Earnings retention ratio)]

= [0.01 * 0.92] / [1 - (0.01 * 0.92)] = 0.0092 / 0.9908 = 0.0093, or 0.93%

Option "3rd" is correct.

b). Option "4th" is correct.

To maintain a sustainable growth model, one of the assumptions of the model is that proportion of sales and assets remains stable.

Other assumptions are, the firm should maintain a constant net profit margin in proportion to sales achieved, and the capital structure and dividend pay out ratio remains the same.