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Sustainable Growth Rate

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?

Solution Preview

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.

What is the firm's sustainable growth rate?

The sustainable growth rate (SGR) is the maximum growth rate a firm can achieve without external equity financing while maintaining a constant debt/equity ratio.
Sustainable growth rate = (ROE x b) / [1 - (ROE x b)].

Sales= $50,000
Assets = $100,000
Debt= $40,000
Therefore, Equity= $60,000 =100000-40000

Debt%= 40% =40000/100000
Equity %= 60% =60000/100000

Net Income= $2,000
Dividend= $500
Therefore, retained income= $1,500 =2000-500

ROE =Return on Equity = Net Income / ...

Solution Summary

Calculates the firm's sustainable growth rate, amount of debt to be issued and the maximum possible rate if the firm did not issue any debt next year.

$2.19