Question

The most recent financial statements for Alexander Co. are shown here: Income Statement Balance Sheet Sales $ 49,600 Current assets $ 22,800 Long-term debt $ 46,000 Costs 37,800 Fixed assets 89,000 Equity 65,800 Taxable income $ 11,800 Total $ 111,800 Total $ 111,800 Taxes (34%) 4,012 Net income $ 7,788 Assets and costs are proportional to sales. The company maintains a constant 20 percent dividend payout ratio and a constant debt–equity ratio. What is the maximum dollar increase in sales that can be sustained assuming no new equity is issued? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

The maximum percentage sales increase is the sustainable growth rate.

To calculate the sustainable growth rate, we first need to calculate the ROE,

which is: ROE = NI / TE

ROE = $7,788 / $65800

ROE = 0.118359, or 11.8359% T

The plowback ratio, b, is one minus the payout ratio, so:

b= 1 – 0.2

b= 0.8

Now we can use the sustainable growth rate equation to get:

Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

Sustainable growth rate = [0.118359(0.8)] / [1 – 0.118359(0.8)]

Sustainable growth rate = 0.1046, or 10.46%

So, the maximum dollar increase in sales is:

Maximum increase in sales = $49,600(0.1046) Maximum increase in sales = $5187.68