Question

What is the “sustainable growth rate” used in planning for growth, and what does the sustainable growth rate assume about issuing new equity (shares of stock) and the debt-to-equity ratio?

Answer 1

Sustainable growth rate: Sustainable growth rate is the maximum growth rate that an entity can sustain without need to increase its financial leverage i.e., borrowing from outside.

It is a measure how fast and how large an entity can grow without borrowing.

Sustainable growth rate is calculated with the help of a formula:

G = Return on equity X (1- Dividend payout ratio)

Assumptions:

Sustainable growth rate assumes that an entity wants to maintain a target debt equity ratio and a static dividend payout ratio.

It also assumes that management is unwilling to issue new euity shares.

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