Question

1) Susie and Sam's has a return on assets of 14 percent, an equity multiplier of 1.8, and a dividend payout ratio of 40 percent. What is their internal rate of growth?

2) La Playa has sales of $45,000, cost of goods sold of $20,000, depreciation of $4,000, and inventory of $5,000. How long on average does it take La Playa to sell its inventory (Days Sales in Inventory)?

3) XYZ corp. has sales of $46,700, cost of goods sold of $28,000, depreciation of $3,700, and inventory of $5,600. What is its Inventory Turnover Ratio?

Answer 1

Internal Growth Rate is the growth rate that a firm can achieve without any external financing. It is the growth rate which is achieved by using internal financing. The formula to calculate Internal Growth Rate :

Internal Growth Rate = (Return on Assets * Retention Ratio)/ 1 – (Return on Assets * Retention Ratio)

Calculation of Retention Ratio :
Retention Ratio = 1 – Payout Ratio
                                   = 1 - 0.40
                                   = 0.60

We have,
Return on Asset = 0.14
Retention Ratio = 0.60

Using the formula,
Internal Growth Rate = (0.14 * 0.60) / 1 - (0.14 * 0.60)
                                          = 0.084 / (1 – 0.084)
                                          = 0.084 / 0.916
                                          = 9.17%

Calculation of Days Sales in Inventory :
Days Sales in Inventory is calculated by = No of days in a period/Receivable Turnover Ratio

where,
Receivable Turnover Ratio = Net Credit Sales/Average Account Receivable

Assuming all the sales to be credit, using the formula
Receivable Turnover Ratio = 45000/5000 = 9

Days Sales in Inventory = 360/9 = 40
Alternatively, we can assume 365 days in a year. In such case
Days Sales in Inventory will be 365/9 = 40.55

Calculation of Inventory Turnover Ratio :
Inventory Turnover Ratio is calculated by dividing Cost of Goods Sold by Average Inventories.
Inventory Turnover Ratio = 28000/5600
    = 5