Question

Medtronic firm has $65,000,000 in equity and $60,000,000 in debt and forecast $ 24,000,000 in net income for the year. It currently pays dividends equal to 15% of its net income.

1. What would their internal growth rate be?

2. What would their sustainable growth rate be?

Answer 1

a)
Internal growth rate = (ROA * retention ratio/(1-ROA * retention ratio))

ROA = Net income / (Equity + Debt)
= $24,000,000 / ($65,000,000 + $60,000,000)
= $24,000,000 / $125,000,000
= 19.20%

Retention ratio = 1 - payout ratio = 1 - 0.15 = 0.85 or 85%

Internal growth rate = (19.20% * 85%) / (1 - 19.20% * 85%)
= 0.1632 / 0.8368
= 19.50%

Internal growth rate = 19.50%

b)
ROE = Net income / Equity
= $24,000,000 / $65,000,000
= 36.92%

Sustainable growth rate = ROE * Retention ratio
= 36.92% * 85%
= 31.38%

Sustainable growth rate = 31.38%

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