Question

2. Varaha Chemicals Limited is interested in estimating its sustainable sales growth rate. Last year, revenues were Rs. 10,00,000, net profit was Rs. 75,000, investment in assets was Rs. 6,00,000, payables and accruals were Rs. 1,20,000, and equity at the end of the year was Rs. 7,25,000 (i.e., beginning-of-year equity of Rs. 6,50,000 plus retained profits of Rs. 75,000). The venture did not pay out any dividends and does not expect to pay dividends for the foreseeable future.

1. Estimate the sustainable sales growth rate for Varaha Chemicals based on the information provided above.   
2. If sales (of Varaha Chemicals) are expected to grow at a rate of 40 percent next year, what would be your estimate of the additional funds needed next year based on the information provided?

Answer 1

a]

SGR = ROE * retention ratio

Retention ratio = 100% (since the company does not pay any dividends, 100% of the profits are retained in the company)

ROE = net profit / average equity

average equity = (beginning equity + ending equity) / 2 = (₹6,50,000 + ₹7,25,000) / 2 =  ₹6,87,500

ROE = ₹75,000 / ₹6,87,500 = 10.91%

SGR = 10.91% * 100% = 10.91%

b]

AFN = ((current level of assets - current level of liabilities) * % increase in sales) - (next year sales * net profit margin * retention ratio)

net profit margin = net income / sales = ₹75,000 / ₹10,00,000 = 7.5%

next year sales = current year sales * (1 + growth rate) =  ₹10,00,000 * (1 + 40%) =  ₹14,00,000

retention ratio = 100%

AFN = ((₹6,00,000 - ₹1,20,000) * 40%) - (₹14,00,000 * 7.5% * 100%)

AFN = ₹87,000