Chapter 4, #6 The most recent financial statements for Alexander Co. are shown h

Question

Chapter 4, #6

The most recent financial statements for Alexander Co. are shown here:

Assets and costs are proportional to sales. The company maintains a constant 30 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.)

Income Statement Balance Sheet   Sales $ 53,200 Current assets $ 25,000 Long-term debt $ 53,500   Costs 42,600 Fixed assets 96,000 Equity 67,500   Taxable income $ 10,600   Total $ 121,000   Total $ 121,000   Taxes (34%) 3,604           Net income $ 6,996

Explanation / Answer

The maximum percentage sales increase is the sustainable growth rate. To calculate the sustainable growth rate, we first need to calculate the ROE, which is: ROI = NI/TE = 6996 / 67500 = 0.103644 or 10.33% The plowback ratio, b, is one minus the payout ratio, so: b = 1 - 0.30 = 0.70 Now we can use the sustainable growth rate equation to get: Sustainable growth rate = (ROE × b) / [1 – (ROE × b)] = 0.103644 * 0.70 / [1 - 0.103644 * 0.70] = 0.072551 / 0.927449 = 0.07823 = 7.823% So, the maximum dollar increase in sales is: Maximum increase in sales = $53200 * 0.07823 = $4,161.65

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