You’ve collected the following information about Odyssey, Inc.: Sales $ 230,000

Question

You’ve collected the following information about Odyssey, Inc.: Sales $ 230,000 Net income $ 15,200 Dividends $ 9,600 Total debt $ 92,000 Total equity $ 68,000 What is the sustainable growth rate for the company? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Sustainable growth rate % If it does grow 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. 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. Round your answer to 2 decimal places. (e.g., 32.16)) Internal growth rate %

Explanation / Answer

Part A)

To calculate sustainable growth rate, we need to determine the Retention Ratio and ROE as follows:

Retention Ratio = 1 - Dividends/Net Income = 1 - 9,600/15,200 = 36.84%

ROE = Net Income/Total Equity = 15,200/68,000 = 22.35%

Now, we can calculate the sustainable growth rate as follows:

Sustainable Growth Rate = ROE*Retention Ratio/(1-ROE*Retention Ratio)

Using the values calculated above, we get,

Sustainable Growth Rate = (22.35%*36.84%)/(1-(22.35%*36.84%)) = 8.97%

_________

Part B)

The value of additional borrowing can be calculated as follows:

Additional Borrowing = New Value of Total Debt - Existing Debt

New Value of Total Assets = (1+Sustainable Growth Rate)*(Debt + Equity) = (1+8.97%)*(92,000 + 68,000) = $174,352

New Value of Total Debt = New Value of Total Assets*Debt Equity Ratio = 174,352*(92,000/(92,000 + 68,000)) = $100,252.40

Additional Borrowing = 100,252.40 - 92,000 = $8,252.40 (it can be $8,256.41 (if no rounding is done))

Notes:

There can be a slight difference in answer on account of rounding off values

_________

Part C)

To calculate the internal growth rate, we need to calculate ROA as follows:

ROA = Net Income/(Total Debt + Total Equity) = 15,200/(92,000 + 68,000) = 9.50%

Now, we can calculate the internal growth rate as follows:

Internal Growth Rate = ROA*Retention Ratio/(1-ROA*Retention Ratio)

Using the values calculated above, we get,

Internal Growth Rate = (9.50%*36.84%)/(1-(9.50%*36.84%)) = 3.63%

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