Question

85. Smith & Daughters is getting ready to compile pro forma statements for the next few years. How can the managers establish a reasonable range of growth rates that they should consider during this planning process:?

Answer 1

Solution:

There are various factors that can be considered while making assumptions for the growth rate-

1. Historical growth rate: The most important factor that can be considered is historical growth rate. Generally this rate provides the fair idea that how much growth the company can expect.
2. Capex utilization: If the company has invested in some Capex and they are able to make production from this assets then we need to factor this in to the growth in revenue.

3. Sustainable growth rate: Sustainable growth rate = ROE * (1 – Dividend pay-out). Sustainable growth rate is the rate that a company can expect with the current funds. So if the company is not raising additional funds in the future then we can use this rate as the proxy for the growth rate.

4. Industry growth rate and the economic cycle of the country: On a broader note the industry growth rate and the economic cycle will also impact the growth rate of the company e.g. at the time of recession we can expect that the growth rate will be lower.