9. Baxter Inc. is in a fast growing industry, but doesn\'t seem to be able to ma
ID: 2664328 • Letter: 9
Question
9. Baxter Inc. is in a fast growing industry, but doesn't seem to be able to match its competitors' growth rates. Selected financial information for Baxter is as follows ($000):
Baxter
Sales $20,000
EAT $ 1,000
Total Assets $10,000
Equity $ 8,000
Annual dividend $ 700
Research has revealed that the average firm in Baxter's industry pays out 10% of its earnings in dividends, earns 4 cents after tax on every sales dollar, has an equity multiplier of 3.0 and a total asset turnover of 1.9.
a. Use a sustainable growth rate analysis in the following table to determine the source(s) of Baxter's growth problems.
gs =
Retention Ratio x
Return on Sales x Total Asset Turnover x Equity Multiplier
Industry
Baxter
b. What negatives might be associated with fixing the problems revealed by the analysis?
Explanation / Answer
Sales = $20,000 Earnings after Tax (EAT) (or) Net Income = $1,000 Total Assets = $10,000 Equity = $8,000 Annual Dividend = $700 Research has revealed that the average firm in Baxter’s industry pays out 10% of its earnings in dividends, earns 4 cents after tax on every sales dollar, and has an equity multiplier of 3.0 and a total asset turnover of 1.9 Equity Multiplier = 3.0 Total Asset Turnover = 1.9 Profit Margin = [Net Income / Sales] Profit Margin = [$1,000 / $20,000] Profit Margin = 0.05 (or) 5% Sustainable growth rate: The maximum possible growth rate for a firm that maintains a constant debt ratio and doesn’t sell new stock. Sustainable growth rate = [(ROE * b) / (1-ROE * b)] ROE = Profit Margin * Total Asset Turnover * Equity multiplier b = Plowback (retention) ratio = Addition to retained earnings / Net Income = 1 – Dividend payout ratio Dividend payout ratio = 10% Plowback (retention) ratio (b) = 1 – 0.10 Plowback (retention) ratio (b) = 0.9 ROE = 0.05 * 1.9 * 3.0 ROE = 0.285 (or) 28.5% Sustainable growth rate = [(0.285 * 0.9) / (1-0.285 * 0.9)] Sustainable growth rate = [0.2565 / (0.715 * 0.9)] Sustainable growth rate = [0.2565 / 0.6435] Sustainable growth rate = 0.3986 (or) 39.86% Sustainable growth rate = 39.86%
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