Question

Loreto Inc. has the following financial ratios: asset turnover = 1.60; net profit margin (i.e., net income/sales) = 6%; payout ratio = 25%; equity/assets = 0.80.

a. What is Loreto's sustainable growth rate?

b. What is its internal growth rate?

Answer 1

Solution:-

1) Computation of Loreto's sustainable growth rate;

Sustainable growth rate = ROE * b

b = retention ratio

ROE = asset tuenover * asset/equity * net profit margin

= 1.6 * 1.25 * 0.06

= 0.12

Retention ratio = 1-pay out ratio

= 1-25%

= 75% or 0.75

Sustainable growth rate = 0.12 * 75%

= 9%

Therefore the sustainable groth rate is 9%

2) Computation of internal growth rate;

Internal growth rate = ROA * b/(1-ROA*b)

ROA = Asset turnover * net profit margin

=1.6 * 6%

= 0.096

Internal growth rate = 0.096 * 0.75 / (1- 0.096 * 0.75)

= 0.072 / 0.928

= 0.0775862 or 7.75862%

Therefore the internal growth rate is 7.75862%