This firm maintains a constant payout ratio and is currently operating at full c

Question

This firm maintains a constant payout ratio and is currently operating at full capacity. What is the maximum rate at which the firm can grow without acquiring any additional external financing?

Use the below information to answer the following question. Income Statement For the Year   Sales $36,200   Cost of goods sold 27,900   Depreciation 2,950   Earnings before interest and taxes $ 5,350   Interest paid 1,180   Taxable income $ 4,170   Taxes 1,270   Net income $ 2,900 Dividends $870 Balance Sheet End-of-Year   Cash $ 350   Accounts receivable 3,150   Inventory 8,300   Total current assets $11,800   Net fixed assets 27,600   Total assets $39,400   Accounts payable $ 3,950   Long-term debt 14,700   Common stock ($1 par value) 12,500   Retained earnings 8,250   Total Liab. & Equity $39,400

This firm maintains a constant payout ratio and is currently operating at full capacity. What is the maximum rate at which the firm can grow without acquiring any additional external financing?

4.74 percent 5.43 percent 3.06 percent 5.58 percent 5.16 percent

Explanation / Answer

Internal Growth Rate = (ROA*b) / [1-(ROA*b)]

Here, ROA is Return on assets= Net income/ Total assets

b is Retention Ratio = 1-(Dividend/ Net income)

ROA = $2,900/ $39,400 = 0.07

b = 1- ($870 / $2,900) =1- 0.3 = 0.7

IGR = (0.07*0.7) / [1- (0.07*0.7)]

= 0.049 / [1- 0.049] = 0.049 / 0.951 = 0.0515 or 5.15%

Therefore, answer is 5.16 percent as it is approximate to 5.15%

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