Question

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Calculate the internal growth rate and sustainable growth rate for S&S Air. What do these numbers mean?

S&S Air is planning for a growth rate of 12 percent next year. Calculate the EFN for the company assuming the company is operating at full capacity. Can the company's sales increase at this growth rate?

Answer 1

Internal growth rate and sustainable growth rate:

To calculate the firm’s internal growth rate and sustainable growth rate, we need to calculate the ROE, ROA and dividend payout ratio first.

The formula for Return on Equity is:

Substitute the values in the formula:

The Return on Equity is 19.3 %( or) 0.193

The formula for Return on Assets is:

Substitute the values in the formula:

The Return on Assets is 10.61 %( or) 0.1061

The dividend payout ratio is calculated by the formula:

Substitute the values in the formula:

The dividend payout ratio is 30.3% (or) 0.303

The formula for retention ratio is:

Substitute the values in the formula:

The retention ratio is 0.697

Internal growth rate:

The formula for internal growth rate is:

Substitute the values in the formula:

The internal growth rate is 7.96%

The sustainable growth rate is given by the formula:

Substitute the values in the formula:

The sustainable growth rate is 0.1554

The internal growth rate is the maximum growth rate that can be achieved with no external financing of any kind. The sustainable growth rate is the maximum growth rate that can be achieved with no external equity financing while maintaining a constant debt-equity ratio.

Answer 2

S&S Air, Inc. 2008 Income statement is as per Page number 117 and S&S Air, Inc. 2008 Balance sheet is as per the book, Page number 118.

Step 1:

All variables are as per given information.

All variables of the income statement will increase by except for depreciation because the fixed assets remain constant without any growth.

Pro forma Income Statement using 12% growth rate:

Particulars	Amount
Sales I
Cost of goods sold II
Other expenses III
Depreciation IV
EBIT V=I-II-III-IV
Interest VI
Taxable income VII=V-VI
Taxes (40%) VIII=VII×40%
Net income IX=VII-VIII
Dividends1 X
Add to retained earnings XI=IX-X

Amount of dividend is assumed to continue as per the original data.

Step 2:

Retained earnings is as per Step 1 and other variables are as per given information.

All variables of the balance sheet increases by except for notes payable and long-term debt.

Notes payable and long-term debt will not be affected by this growth rate.

Assets	Amount	Liabilities and Equity	Amount
Current assets		Current liabilities
Cash		Accounts payable
Accounts receivables		Notes payable
Inventory		Total current liabilities
Total current assets		Long-term debt
Fixed assets
Net plant and equipment	1	Shareholder equity
		Common stock
		Retained earnings	2
		Total equity
Total assets		Total liabilities and equity

Yes, the firm can grow at this rate provided if it makes some slight alternations in the way it operates.

For instance: The profit margin of the firm increases, this can be increased by reducing the costs which in turn will increase the ROE of the firm and finally will increase the substantial growth of the firm.

To be precise as long as the firm is able to increase its profit margin, total asset turnover or the equity multiplier there are chances of higher growth rate. One important thing to be noted is that any slight change in any one of the variable will have effect on the pro forma financial statements of the firm.