You\'ve collected the following information about Erna, Inc.: Sales Net income D

Question

You've collected the following information about Erna, Inc.: Sales Net income Dividends Total debt Total equity - $300,000 - $ 18,100 $6,900 64,000 $95,000 What is the sustainable growth rate for the company? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Sustainable growth rate Assuming it grows at this rate, how much new borrowing will take place in the coming year, assuming a constant debt-equity ratio? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Additional borrowing What growth rate could be supported with no outside financing at all (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Growth rate

Explanation / Answer

Solution: a. Sustainable growth rate 13.37% Working Notes: Sustainable growth rate = (ROE × b) / [1 – (ROE × b)] Where b = retention ratio ROE = return on Equity b= retention ratio = 1 - (dividend/net income) b= 1 - (6,900/18,100) b=1-0.38121546961 b=0.61878453039 ROE = return on Equity = Net income / total Equity ROE= 18,100/95,000 ROE=0.19052631578 Sustainable growth rate = (ROE × b) / [1 – (ROE × b)] =(0.19052631578 x 0.61878453039)/(1-(0.19052631578 x 0.61878453039)) =0.133651551 =13.3651551 % =13.37% b. Additional borrowing $8,553.70 Working Notes: At above sustainable growth rate New total assets = (1+ growth rate ) x (total debt + total equity) =(1.133651551) x (64,000+95,000) =(1.133651551) x 159,000 =$180,250.59661 =$180,250.60 As company will maintain debt equity ratio therefore new total debt (New TD) New TD = (D / (D + E)) x New total assets New TD = (64,000 / (64,000 + 95,000)) x $180,250.59661 New TD = $72,553.69926 New TD = $72,553.70 Additional borrowing = New TD - Old debt =$72,553.70 -64,000 =$8,553.70 c. Growth rate 7.58% Working Notes: Internal growth rate = (ROA × b) / [1 – (ROA × b)] ROA = return on assets = Net income / (total assets) ROA = return on assets = Net income / (total debt + total equity) ROA = return on assets = 18,100 / (64,000 + 95,000) ROA = 0.113836477987 b= retention ratio b=0.61878453039 as calculated in a. Internal growth rate = (ROA × b) / [1 – (ROA × b)] =( 0.113836477987 x 0.61878453039) /(1-( 0.113836477987 x 0.61878453039)) =0.75778078 =0.0758 =7.58% Please feel free to ask if anything about above solution in comment section of the question.

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