Question

The financial statements of Eagle Sport Supply are shown in the table below. For simplicity, “Costs” include interest. Assume that Eagle’s assets are proportional to its sales. Assume a growth rate of 15% in revenue, expenses, and assets in 2018. The tax rate will remain constant.. Income Statement Sales $ 950 Costs 250 Pretax income $ 700 Taxes (at 28.6%) 200 Net income $ 500 Balance Sheet, Year-End 2017 2016 2017 2016 Assets $ 3,000 $ 2,700 Debt $ 1,000 $ 900 Equity 2,000 1,800 Total $ 3,000 $ 2,700 Total $ 3,000 $ 2,700 a. Assume that the dividend payout ratio is fixed at 60% and the equity-to-asset ratio is fixed at two-thirds. What is the internal growth rate for 2018? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Internal growth rate % b. What is the sustainable growth rate for 2018? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Sustainable growth rate % References

Answer 1

Solution :

For internal and sustainable growth we need to find ROA, ROE and retention rate (b)

ROA = 16.67% , ROE = 25% b = 1 - dividend payout = 1 -0.6 = 0.4

Calculations are given in the excel sheet

Part A )

Internal growth rate: This rate is due to return on assets and it can be calculated by

Internal growth rate = ROA * b / (1 - ROA *b ) = 16.67% . 0.4 / ( 1 - 16.67% *0.4 ) = 0.066659 / 0.933341 = 0.07141 = 7.14%

Part B )

Sustainable growth rate : It the maximum growth a company can have without taking outside finance

Sustainable growth rate = ROE * retention ratio = 25% *0.4 = 10.00%