Question

The most recent financial statements for Alexander Co. are shown here: Income Statement Balance Sheet Long-term debt Current $45,350 $18,860 $37,870 Sales assets Costs 36,350 Fixed assets 69,150 Equity 50,140 Taxable $88,010 $88,010 9,000 Total Total income Taxes (22% 1,980 Net income $ 7,020 Assets and costs are proportional to sales. The company maintains a constant 35 percent dividend payout ratio and a constant debt-equity ratio What is the maximum dollar increase in sales that can be sustained assuming no new equity is issued? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Maximum dollar increase

Answer 1

The maximum dollar increase in sales that can be sustained assuming no new equity is issued is computed as follows:

First of all we shall calculate return on equity as follows:

ROE = Net income / Equity

= $ 7,020 / $ 50,140

= 14%

The retention ratio will be

= 1 - dividend payout ratio

= 1 - 0.35

= 0.65

Now the sustainable growth rate formula is

= (ROE × b) / [1 - (ROE × b)]

= ( 0.14 x 0.65 ) / [ 1 - ( 0.14 x 0.65 ) ]

= 10.01%

So, the maximum dollar increase in sales is

= $ 45,350 x 0.1001

= $ 4,539.54 Approximately

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