Question

As a firm grows, it must support increases in revenue with new investments in assets. The self-supporting, or sustainable, growth model helps a firm assess how rapidly it can grow, while maintaining a balance between its cash outflows (increases in noncash assets) and inflows (funds resulting from increases in liabilities or equity). Consider the following case of Bohemian Manufacturing Company: Bohemian Manufacturing Company has no debt in its capital structure and has $300,000,000 in assets. Its sales revenues last year were $120,000,000 with a net income of $2,000,000. The company distributed $180,000 as dividends to its shareholders last year. Given the information above, what is Bohemian Manufacturing Company’s sustainable growth rate? 0.0601562% 0.5181384% 0.61% 4.1464268% Which of the following are assumptions of the sustainable (self-supporting) growth model? Check all that apply. The firm maintains a constant net profit margin. The firm’s liabilities and equity must increase at the same rate. The firm pays no dividends. The firm maintains a constant ratio of liabilities to equity.

Answer 1

Answer:

Sustainable growth rate =  0.67148%

The firm maintains a constant ratio of liabilities to equity.

Explanation:

Sustainable growth rate = ROE *Plow back Ratio / (1-ROE * Plow back Ratio)

When ROE = Net Income / Total Assets

= $2,000,000/$300,000,000

= 0.00667

Plow back Ratio = 1 - (Dividend / Net Income)

= 1 - ($180,000/$2,000,000)

= 1 - 0.09

=0.91

Sustainable growth rate = ROE * Plow back Ratio / (1-ROE * Plow back Ratio)

= 0.00667 * 0.91 / (1 - 0.00667  * 0.91)

= 0.0060697 / 0.9039303

=0.0067148

= 0.67148%

Therefore, the sustainable growth rate is 0.67148%

The firm maintains a constant ratio of liabilities to equity is the correct assumption for the sustainable growth model.