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# Maximum sustainable growth rate

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Assume that a firm has a net income in 20x9 of \$20 and its end-of-year 20x8 total assets were \$450. Further assume that the firm has a standing requirement to maintain a debt/equity ratio of 0.8, and that its managers are prohibited from further borrowing or stock issuance.

a. What is this firm's maximum sustainable growth rate?

b. If the firm pays \$6 of the \$20 net income as a dividend, and plans to maintain this payout ratio into the future, now what is
its maximum sustainable growth rate?

c. If the firm uses \$12 of the \$20 net income to repurchase some of its outstanding shares, now what is its maximum
sustainable growth rate?

d. If the firm takes action as described in parts b and c, what would its maximum sustainable growth rate be?

#### Solution Preview

a. What is this firm's maximum sustainable growth rate?

Debt/Equity = .8;

Assets = \$450; Debt = \$200; Equity = \$250;

growth rate = 20/250 =8%

b. If the firm pays \$6 of the \$20 net ...

#### Solution Summary

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## A) What is the firm's sustainable growth rate? b) If the firm grows at its sustainable growth rate, how much debt will be issued next year? c) What would be the maximum possible rate if the firm did not issue any debt next year?

A company had net income of \$2000 on sales of \$50,000 last year. The company paid a dividend of \$500. Total assets were \$100,000, of which \$40,000 was financed by debt.

a) What is the firm's sustainable growth rate?

b) If the firm grows at its sustainable growth rate, how much debt will be issued next year?

c) What would be the maximum possible rate if the firm did not issue any debt next year?

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