5.Arcadia Enterprises would like to grow 10% per year foe the foreseeable future

Question

5.Arcadia Enterprises would like to grow 10% per year foe the foreseeable future . The firm’s financial statements are provided below (in $000’s)

Income Statement

Sales 1400

Cost of Sales 700

Depreciation 200

Interest 150

Taxes(34%) 119

Net Income 231

Dividends 169

Total 2969

Balance Sheet

Current Assets 1891    Current Liabilities 1173

Net Fixed Assets 1689 Long Term Debt 945

   Common Stock 959

   Retained Earnings 503

Total 3508 3580

(a)Calculate the internal and sustainable growth rates for Arcadia?

(b)Why is there a difference i the internal and sustainable growth rates ? ( Do not just repeat the formulas . Tell me why one has a higher growth than the other.I.e What is making the firm able to grow in the firm able to grow in the case of the case of the higher growth rate?)

(c)What dividend payout ratio should Arcadia adopt to achieve its 10% growth objective?

Explanation / Answer

(a)

Calculate the internal and sustainable growth rates for Arcadia:

Internal Growth Rate (IRG) = Retained Earnings / Total Assets

Also IRG =

(ROA * b) / 1 - (ROA * b)...where b = retention ratio (1 - payout ratio)

ROA = $231/$3,508 = 0.065849

ROA * b = 0.065849 * .66 = 0.04346

0.04346 / (1-.04346) = 0.04346 / 0.9554 = 0.04549 or about 4.55%

Sustainable growth rate (SGR) = ROE * (1- dividend payout ratio)

ROE = Net income / Shareholders equity

= $231 / ($959 + $503)

=$231 /$1462

= 0.158

Dividend payout ratio = Dividend / Net income

= $169 / $231

= 0.7316

SGR = 0.158 * (1-0.7316)

= 0.04241

Therefore, Sustainable growth rate is 0.04241 or 4.241%

b)

Difference the internal and sustainable growth rates:

Internal Growth Rate (IRG) is 4.55% and Sustainable growth rate (SGR) is 4.241%

c)

Dividend payout ratio = Dividend / Net income

= $169 / $231

= 0.7316 + (0.7316 *10%)

= 0.7316 + 0.07316

= 0.80476

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