Question

Narrow Falls Lumber has total assets of $913,600, total debt of $424,500, net sales of $848,600, and net income of $94,000. The tax rate is 21 percent and the dividend payout ratio is 30 percent. What is the firm's sustainable growth rate? Assuming all external funds will come from debt, will the firm’s debt-equity ratio change if it grows at the sustainable growth rate? (Hint: Need to compute Total Equity, ROE, and the fraction reinvested. Choose closest answer if necessary).

Group of answer choices:

A. 15.54 percent; Decrease

B. 15.54 percent; Constant

C. 6.12 percent; Increase

D. 6.12 percent; Constant

Answer 1

Sustainable growth rate	ROE*(1-dividend payout ratio)/(1-(ROE*(1-Dividend payout ratio))
ROE	Net income/Shareholder's equity
ROE	94000/(913600-424500)
ROE	94000/489100
ROE	19.22%
Sustainable growth rate	19.22%*(1-0.30)/(1-(0.1922*(1-0.30)))
Sustainable growth rate	19.22%*0.70/(1-0.134533)
Sustainable growth rate	15.54%
Thus, sustainable growth rate is 15.54%
Sustinable growth rate is the increase in sales for next year which would not change in the debt/equity ratio if company grows at this rate.
The increase in debt and equity would be in same proportion and thus the debt equity ratio would remain constant.
Thus, correct answer is option (B)