Question

Sustainable Growth. In the chapter, we used Rosengarten Corporation to demonstrate how to calculate EFN. The ROE for Rosengarten is about 7.3 percent, and the plowback ratio is about 67 percent. If you calculate the sustainable growth rate for Rosengarten, you will fi nd it is only 5.14 percent. In our calculation for EFN, we used a growth rate of 25 percent. Is this possible? ( Hint: Yes. How?)

Answer 1

There are two assumptions of the sustainable growth formula:

1. The company does not want to sell new equity, and 2. financial policy is fixed.

So, if the company raises outside equity, or increases its debt-equity ratio, it can grow at a higher rate than the SGR.

Or the company can also grow faster if is changes one or more components of the ROE, i.e., its profit margin increases, or its total asset turnover increases.

Or, if it changes its dividend policy by increasing the retention ratio.