Question

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

Income Statement				Balance Sheet
Sales	$	52,200		Current assets	$	22,000		Long-term debt	$	45,500
Costs		42,100		Fixed assets		91,000		Equity		67,500
Taxable income	$	10,100		Total	$	113,000		Total	$	113,000
Taxes (34%)		3,434
Net income	$	6,666

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 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.)

Maximum increase in sales

$

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)]

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

= [$6,666 / $67,500] x 100

= 9.88%

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

= [0.0988 x (1 – 0.20)] / [1 – {0.0988 x (1 - 0.20)}]

= [0.0988 x 0.80] / [1 – (0.0988 x 0.80)]

= [0.0790 / 0.9210]

= 0.0858 or

= 8.58%

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

= $52,200 x 8.58%

= $4,478.76

“Hence, The Maximum Dollar Increase would be $4,478.76”