Question

Sustainable Growth Rate You are considering investing in Annie’s Eatery. You have been able to locate the following information on the firm: Total assets are $40 million, accounts receivable are $6.0 million, ACP is 30 days, net income is $4.75 million, debt-to-equity is 1.5 times, and dividend payout ratio is 45 percent. All sales are on credit. Annie’s is considering loosening its credit policy such that ACP will increase to 35 days. The change is expected to increase credit sales by 5 percent. Any change in accounts receivable will be offset with a change in debt. No other balance sheet changes are expected. Annie’s profit margin and dividend payout ratio will remain unchanged. Use the DuPont equation to determine how this change in accounts receivable policy will affect Annie’s sustainable growth rate.

Answer 1

SGR = ROE*b/(1-ROE*b), where b is the retention
rate.
EXISTING POLICY:
ROE (Using DuPont equation) = Total assets turnover*Profit margin*Equity multiplier
or
Return on total assets*Equity multiplier
= (4.75/40)*2.5 =	0.2969
SGR = 0.2969*0.55/(1-0.2969*0.55) =	19.52%
PROPOSED POLICY:
ROE = (4.75/40)*(40.11/16) =	0.2977
SGR = 0.2977*0.55/(1-0.2977*0.55) =	19.58%
CALCULATIONS:
Increase in receivables = 6.0*1.05*35/365-6.0*30/365 =	0.11
Total assets = 40+0.11 =	40.11
Equity = 40*1/2.5	16.00
EFFECT ON SGR:
The SGR will increase form 19.52% to 19.58%.