GBK, Inc. has sales of 10,552; total assets of 6210; and a debt-equity ratio of

Question

GBK, Inc. has sales of 10,552; total assets of 6210; and a debt-equity ratio of 1.40. If its return on equity is 15%, what is its net income? (You may, or may not, find the Du Pont Identity helpful.)

Problem 2-2

You have collected the following information about Your Firm, Inc.:
     Sales = 215,000
     Net Income = 19,200
     Dividends = 10,200
     Total Debt = 96,000
     Total Equity = 64,000

A] What is the sustainable growth rate for Your Firm, Inc.?
B] If it does grow at this rate, how much new borrowing will take place in the coming year, assuming a constant debt-equity ratio?
C] What growth rate could be supported with no outside financing at all?

Explanation / Answer

1) ROA = ROE * (Debt + Equity) / Equity

= 15% * (1.40+ 1 ) / 1

= 36%

Net income = 6210 * 36% = 2235.60

2)

A) Sustainable growth rate = ROE * (1 - Payout ratio)

= (19200 / 64000) * (1 - 10200 / 19200)

= 14.06%

B) Retention ratio = (1 - 10200 / 19200) = 46.875%

Funds reuired = (96000 + 64000) * 14.06% - (19200*1.1406 * .46875) = 12230.60

Borrowing = 12230.60 * 96000 / (96000+ 64000) = 7338.36

C) Let assume growth rate is x:

Increase in total assets = Current year profit * (1 + Growth rate) * Retention ratio

(96000 + 64000) * x = 19200 * (1 + x) * .46875

160000x = 9000 + 9000x

x = 5.96%

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