Question

Currently, market value of FGH Company is $200,000 and its Debt/Equity ratio is 1/3. If the company wants to grow without changing its capital structure, it must issue an additional $6,000 of new debt. What is the company’s internal growth rate?

Answer 1

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Solution

Given that

MV = 200,000

D/E = 1/3

=> Debt = 1/(3+1) * 200,000 = 50,000

Equity = 3/(3+1) * 200,000 = 150,000

New debt issued = 6000

So total debt = 50000+6000 = 56000

The D/E structure is not changed, hecnce the new value of the company = 56000 * 4 = 224,000

Vaue of equity = 224,000 * 3/4 = 168,000

Growth rate is computed as the change in equity divided by old equity

=> (168,000 - 150,000) / 150,000 * 100

= 12%