Question

Suppose a firm maintains a positive retention ratio and keeps
its debt-equity ratio constant every year. When sales grow by 20%,
the firm has a negative projected EFN.

a) Can you tell, with certainty, that the sustainable growth rate
is greater than/equal to/ less than 20%? Why/Why not?

b) Do you know with certainty that the internal growth rate is
greater than/equal to/ less than 20%? Why/Why not?

Answer #1

a)

The sustainable growth rate is greater than 20%. This is because
even at 20% growth rate, negative project EFN portrays that excess
funding is still available for the firm. In short, there is still
excess internal financing suggesting that the **sustainable
growth rate is greater than 20%.**

b)

The sustainable growth rate in this case is greater than 20%. The internal growth rate is always lesser than the sustainable growth rate when the firm has any equity finance lesser than 100%, ie. the firm has some debt. Only if the firm is 100% equity financed, the sustainable growth rate and the internal growth rate are equal.

Here, we **cannot be able to say with certainty**
about the internal growth rate whether it would be greater than,
equal to or lesser than 20%.

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