Question

Problem 4-7 Calculating Sustainable Growth [LO3]

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

Income Statement				Balance Sheet
Sales	$	14,400		Current assets	$	11,700		Debt	$	16,200
Costs		9,600		Fixed assets		28,250		Equity		23,750
Taxable income	$	4,800		Total	$	39,950		Total	$	39,950
Taxes (40%)		1,920
Net income	$	2,880

Assets and costs are proportional to sales. Debt and equity are not. The company maintains a constant 20 percent dividend payout ratio. No external equity financing is possible.

What is the sustainable growth rate? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Sustainable growth rate

%

Answer 1

The maximum percentage sales increase is the sustainable growth rate.

To calculate the sustainable growth rate, we first need to calculate the ROE, which is:

ROE

= NI / TEROE

= 2880 / 23750

= 0.1212 or 12.12%

The plowback ratio, b, is one minus the payout ratio, so:

b = 1 − .20b

= .80

Now we can use the sustainable growth rate equation to get:

Sustainable growth rate

= (ROE × b) / [1 − (ROE × b)]

Sustainable growth rate

= [0.1212(0.80)] / [1 - 0.1212(0.80)]

= 0.1073 or 10.73%

Sustainable growth rate = 10.73%