As a firm grows, it must support increases in revenue with new investments in as

Question

As a firm grows, it must support increases in revenue with new investments in assets. The self-supporting growth model helps a firm assess how rapidly it can grow, while maintaining a balance between its cash outflows (increases in noncash assets) and inflows (funds resulting from increases in liabilities or equity). Consider this case: Green Caterpillar Garden Supplies Inc. has no debt in its capital structure and has $200 million in assets. Its sales revenues last year were $100 million with a net income of $5 million. The company distributed $1.10 million as dividends to its shareholders last year. What is the firm's self-supporting growth rate? 3.15% 0.35% 0.55% 1.99% Which of the following are assumptions of the self-supporting growth model? Check all that apply. The firm will not issue any new common stock next year. The firm pays out a constant proportion of its earnings as dividends The firm's total asset turnover ratio remains constant. The firm uses all equity and no debt financing L

Explanation / Answer

Firm's self supporting growth rate is the growth that a firm can sustain without raising external financing either debt or equity.

Self suppoting growth rate = ROE*(1-dividend payout ratio)

In this case, Divends = $1.1 million

Net income = $5 million

Dividends payout ratio = Dividends / Net income = 1.1/5 = 0.22

ROE = Net Income / Shareholders equity

The firm has no debt, so entire capital is equity

Therefore, shareholders equity = $200 million

ROE = 5/200 = 0.025

Growth rate = 0.025*(1-0.22) = 0.0195 i.e 1.95%

So the option closest is 1.99%

Therefore, the answer is option 'd'.

b). Assumptions of self supporting growth is that capital structure will be same and firm will not raise any external financing, will maintain same capital structure and it will maintain a constant dividend payout ratio

So, from all the options the answer is option 1, option 2 and option 4

i.e. The firm will not issue any new common stock next year

The firm pays out a constant proportion of its earninggs as dividends

The firm uses all equity and no debt financing

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