Question

The most recent financial statements for Alexander Co. are shown here: Income Statement Balance Sheet Sales $ 44,300 Current assets $ 18,300 Long-term debt $ 37,520 Costs 36,000 Fixed assets 68,800 Equity 49,580 Taxable income $ 8,300 Total $ 87,100 Total $ 87,100 Taxes (25%) 2,075 Net income $ 6,225 Assets and costs are proportional to sales. The company maintains a constant 40 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

Net Income = $6,225
Equity = $49,580

Return on Equity, ROE = Net Income / Equity
Return on Equity, ROE = $6,225 / $49,580
Return on Equity, ROE = 0.1256 or 12.56%

Payout Ratio = 40%

Retention Ratio, b = 1 - Payout Ratio
Retention Ratio, b = 1 - 0.40
Retention Ratio, b = 0.60

Sustainable Growth Rate = [ROE * b] / [1 - ROE * b]
Sustainable Growth Rate = [0.1256 * 0.60] / [1 - 0.1256 * 0.60]
Sustainable Growth Rate = 0.07536 / 0.92464
Sustainable Growth Rate = 0.0815 or 8.15%

Current Year Sales = $44,300

Maximum Increase in Sales = Current Year Sales * Sustainable Growth Rate
Maximum Increase in Sales = $44,300 * 8.15%
Maximum Increase in Sales = $3,610.45