Question

Narrow Falls Lumber has total assets of $913,600, total debt of $424,500, net sales of $848,600, and net income of $94,000. The tax rate is 21 percent and the dividend payout ratio is 30 percent. What is the firm's sustainable growth rate? Assuming all external funds will come from debt, will the firm’s debt-equity ratio change if it grows at the sustainable growth rate? (Hint:
Need to compute Total Equity, ROE, and the fraction reinvested. Choose closest answer if necessary).

Group of answer choices

A. 15.54 percent; Increase

B. 15.54 percent; Decrease

C. 15.54 percent; Constant

D. 6.12 percent; Increase

E. 6.12 percent; Constant

Answer 1

Solution:

Option A (15.54%; Increase) is the correct answer.

Explanation:

Total equity = $913600 - $424500 = $489100

Return on equity = Net income / Total Equity

Return on equity = $94000 / ($489100)

Return on equity = 19.22%

Retention ration 70%

Sustainable growth = (19.22%*70%) / (1 - (19.22%*70%))

Sustainable growth = 15.54%

Assuming all external funds will come from debt, the firm's debt-equity ratio will increase if it grows at the sustainable growth rate