Question

Information of Company X:

Answer 1

Answer:

a. Calculate Company X's sustainable growth rate

sustainable growth rate = retention rate x return on equity

retention rate = ($12,400 - $8,200) / $12,400 = 33.87%

ROI = $12,400 / $54,000 = 22.96%

g = 33.87% x 22.96% = 7.78%

b. In question (ii), we assume that Company X's management wants to maintain a constant debt-equity ratio and in the next year, the growth rate of Company X is what we've calculated in question (i).Calculate the amount of new debt that Company X has to take.

I will assume that the whole debt is current debt and it changes proportionally as the company's sales grow.

EFN = ($118,000/$160,000) x ($12,448) - ($64,000/$160,000) x ($12,448) - (0.0775 x $172,448 x 0.0778) = $9,180 - $4,979 - $1,040 = $3,161

c. If Company X's management does not want any external financing, what would be the growth rate

ROA = $12,400 / $118,000 = 10.51%

Internal growth rate = (10.51% × 33.87%) / [1 - (10.51% × 33.87%)] = 3.56% / 0.9644 = 3.69%