Holooly Plus Logo
Holooly Plus Logo

Question 19.ss.3: Use the financial statements from Problem 19.1 and the infor...

Use the financial statements from Problem 19.1 and the information from Problem 19.2 to calculate the company’s retention (plowback) ratio, external funds needed (EFN), internal growth rate (IGR), and sustainable growth rate (SGR).

The blue check mark means that this solution has been answered and checked by an expert. This guarantees that the final answer is accurate.
Learn more on how we answer questions.

The retention (plowback) ratio, external funds needed, internal growth rate, and sustainable growth rate are calculated as follows:

\begin{matrix} \text{Retention (plowback) ratio} &=&\frac{ \text{Addition to retained earnings}}{ \text{Net income}} \\ \\ &=&\frac{\$159,985}{\$290,882} \\ \\ &=&0.55, \ or \ 55\% \end{matrix} \begin{matrix} EFN &=& ( \text{Growth rate} \times \text{Initial assets)-Addition to retained earnings} \\ &=&(0.20 \times \$574,552)-\$159,985 \\ &=&-\$45,075 \end{matrix}

Thus, without considering the investment of $225,000 for the new facility, the firm will not need any external financing. However, if you add the investment, then,

\begin{matrix} EFN &=& \text{New investments-Addition to retained earnings} \\ &=&(0.20 \times \$574,552)+\$225,000-\$159,985 \\ &=& \$179,925 \end{matrix}

 

\begin{matrix} IGR &=& \frac{ \text{Addition to retained earnings}}{\text{Initial assets}}\\ \\ &=&\frac{\$159,985}{\$574,552} \\ \\ &=& 0.278, \ or \ 27.8\% \end{matrix}

 

\begin{matrix} SGR &=& \text{Plowback ratio} \times ROE \\ \\ &=& \frac{ \text{Addition to retained earnings}}{ \text{Net income}} \times \frac{ \text{Net income}}{ \text{Total equity}} \\ \\ &=&0.55 \times 0.715 \\ \\ &=&0.393, \ or \ 39.3 \% \end{matrix}

Related Answered Questions

Question: 19.A.3

Sustainable Growth and Financial Statements PROBLEM: Because of your presentation (see Decision-Making Example 19.2), Empire’s top management team has had second thoughts about their goal of growing the firm 20 percent during the next year. As a result, they have asked that you prepare pro forma ...

Verified Answer:

Sales = $100 million × 1.133 = $113.30 millionCost...
Question: 19.2

Empire’s Ambitious Growth Plan SITUATION: You are part of the Empire Enterprises finance team. The firm’s strategic plan calls for revenues to grow at 20 percent next year. As mentioned, the board of directors is not interested in using any additional external equity financing. Some members of the ...

Verified Answer:

DECISION: You begin by applauding the visionary na...
Question: 19.1

Informed Judgment about Risk SITUATION: You are given some additional information about Sleepy Hollow Corporation’s use of financial leverage, as shown: Debt to total assets before capital project = $400/$600 = 66.7% Debt to total assets after capital project = $660/$890 = 74.2% Industry average ...

Verified Answer:

DECISION: Sleepy Hollow’s current leverage ratio o...
Question: 19.A.2

Blackwell’s Alternative Plan PROBLEM: Let’s continue the Blackwell Sales case. Suppose that Blackwell’s management now decides to pay a cash dividend but to reduce the payout to 10 percent of net income. Reconcile Blackwell’s retained earnings account. APPROACH: First, we must calculate the new ...

Verified Answer:

The calculations for the new dividend payout and t...
Question: 19.A.1

Financial Statement Items Often Vary with Sales PROBLEM: You have the following information: (1) sales this year are $50 million; (2) sales are expected to grow by 20 percent next year; and (3) for the current year, accounts receivable are 7 percent of sales and inventory is 10 percent of sales. ...

Verified Answer:

\begin{matrix} \% \Delta S &=& \fra...
Question: 19.ss.1

The Starlight, Inc., financial statements for the fiscal year ended June 30, 2011, are presented below. The firm’s sales are projected to grow at a rate of 20 percent next year, and all financial statement accounts will vary directly with sales. Based on that projection, develop a pro forma balance ...

Verified Answer:

Starlight, Inc. Balance Sheet as of June 30, 2012 ...
Question: 19.ss.2

Use the financial information for Starlight from Problem 19.1. Assume now that equity accounts do not vary directly with sales, but change when retained earnings change or new equity is issued. The company pays 45 percent of its income as dividends every year. In addition, the company plans to ...

Verified Answer:

The pro forma income statement is the same as that...
Question: 19.ss.4

Northwood Corp. has a dividend payout ratio of 60 percent, return on equity of 14.5 percent, total assets of $11,500,450, and equity of $4,652,125. Calculate the firm’s internal rate of growth (IGR). ...

Verified Answer:

We calculate Northwood’s internal growth rate as f...
Question: 19.ss.5

Renewal Company has net income of $1.25 million and a dividend payout ratio of 35 percent. It currently has equity of $2,875,223. What is the firm’s sustainable growth rate? ...

Verified Answer:

Renewal’s sustainable growth rate is: \begi...