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Optimal Scan: Sustainable Growth Rate

The Optimal Scam Company would like to see its sales grow at 20 percent for the foreseeable future. Its financial statements for the current year are presented below.

Income Statement ($ millions) Balance Sheet ($ millions)
Sales 32.00 Current assets 16
Costs 28.97 Fixed assets 16
Gross profit 3.03 Total assets 32
Taxes 1.03
Net income 2.00 Current debt 10
Long-term debt 4
Dividends 1.40 Total debt 14
Retained earnings 0.60 Common stock 14
Ret. earnings 4
Total liabilities and equity 32

The current financial policy of the Optimal Scam Company includes
Dividend-payout ratio (d) = 70%
Debt-to-equity ratio (L) = 77.78%
Net profit margin (P) = 6.25%
Assets-sales ratio (T) =1

Determine Optimal Scam's need for external funds next year.
Construct a pro forma balance sheet for Optimal Scam.
Calculate the sustainable growth rate for the Optimal Scam Company.
How can Optimal Scam change its financial policy to achieve its growth objective?

See attached file for full problem description.

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Solution Preview

Since you are making a projection for one year in the future it is reasonable to assume that fixed costs do not change. Thus, if sales grow 20%, then net income will grow 20%. Net income is $2,000,000(1.2) = $2,400,000.
Determine total uses of funds.

The increase in net working capital is growth rate (current assets - current liabilities)

NWC = 0.20 ($16,000,000 - $10,000,000) = $1,200,000
The increase in fixed assets is growth rate X existing ...

Solution Summary

The solution explains the calculation of sustainable growth rate