Question

The most recent financial statements for Mc Govney Co. are shown here:

Income Statement
Sales	$47152
Costs	$36870
Taxable Income	?
Taxes (34%)	?
Net Income	?

Balance Sheet
Current Asset	$21260	Long-term Debt	$48216
Fixed Asset	$85534	Equity	?

Assets and costs are proportional to sales. The company maintains a constant 19 percent dividend payout ratio and a constant debt–equity ratio.

What is the maximum increase in sales (in $) that can be sustained assuming no new equity is issued?

(Omit the "$" sign and commas in your response. Enter your answer rounded to 2 decimal places. For example, $1,200.456 should be entered as 1200.46.)

Answer 1

The Maximum increase in sales is calculated by multiplying the current sales with the sustainable growth rate

Calculation of sustainable growth rate

Sustainable Growth Rate = [ROE x (1-Dividend Pay-out ratio)] / 1- [ROE x (1-Dividend Pay-out Ratio)]

Net Income = (Sales – costs) x (1 – Tax Rate)

= ($47,152 – 36,870) x (1 - 0.34)

= $6786.12

Equity = Total Assets – Long term debt

= ($21260 + 85,534) – 48,216

= $58,578

Return on Equity [ROE]= [Net Income / Equity] x 100

= [$6,786.12 / 58,578) x 100

= 11.58%

Sustainable Growth Rate = [ROE x (1-Dividend Pay-out ratio)] / 1- [ROE x (1-Dividend Pay-out Ratio)] x 100

= [0.1158 x (1 – 0.19)] / 1 - [0.1158 x (1 - 0.19)] x 100

= [0.0938 / 0.9062] x 100

= 10.35%

Therefore, the maximum increase in sales = Current Sales x Sustainable growth rate

= $47,152 x 10.35%

= $4,880.23

“Hence, The maximum increase in sales = $4,880.23”