Concept explainers
Internal and Sustainable Growth Rates. Best Buy reported the following numbers (in millions) for the years ending February 1, 2014, and January 31, 2015. What are the internal and sustainable growth rates? What are the internal and sustainable growth rates using
2014 | 2015 | |
Net income | $ 1,233 | |
Dividends | 251 | |
Total assets | $14,013 | 15,256 |
Total equity | 3,986 | 4,995 |
To discuss: The internal growth rate and sustainable growth rate and calculate the rates, growth rate by using the starting of period equity, the reason for the similar growth rates and the best estimate the internal and sustainable growth rates.
Introduction:
The rate of internal growth is the highest growth rate which can be achieved without any kind of external financing. The rate of sustainable growth is the highest growth rate which can be achieved without external equity financing.
Answer to Problem 45QP
The ROA in the beginning is 8.80% and in the end is 8.08% respectively. The ROE in the beginning is 30.93% and the ROE in the end is 24.68%.
Explanation of Solution
Given information:
The net income of Company B for the year 2015 is $1,233. The dividend in the year 2015 is 251. The total assets for the year 2014 and 2015 are $14,013 and $15,256 respectively. The total equity for 2014 and 2015 are $3,986 and $4,995 respectively.
Formula to compute the ROA in the beginning:
Compute the ROA in the beginning:
Hence, the ROA in the beginning is 8.80%.
Compute the ROA in the end:
Hence, the ROA in the end is 8.08%.
Formula to compute the ROE using the starting period equity:
Compute the ROE using the starting period equity:
Hence, the ROE in the beginning is 30.93%.
Compute the ROE using the end of period equity:
Hence, the ROE in the end is 24.68%.
Formula to compute the retention ratio:
Compute the retention ratio:
Hence, the retention ratio is 79.64%.
Formula to compute the internal growth rate:
Where,
ROA denotes the return on assets.
b denotes the retention or plowback ratio.
Calculate the internal growth rate:
Hence, the internal growth rate is 6.88%.
Formula to calculate the sustainable growth rate:
Where,
ROE denotes the return on equity.
b denotes the retention or plowback ratio.
Compute the sustainable growth rate:
Hence, the sustainable growth rate is 24.47%.
Formula to compute the internal growth rate using ROA at the end:
Compute the internal growth rate using ROA at the end:
Hence, the internal growth rate is 6.44%.
Formula to compute the sustainable growth rate using ROE at the end:
Compute the sustainable growth rate using ROE at the end:
Hence, the sustainable growth rate is 19.66%.
Formula to compute the internal growth rate using ROA at the beginning:
Compute the internal growth rate using ROA at the beginning:
Hence, the internal growth rate is 7.01%.
Formula to compute the sustainable growth rate using ROE at the beginning:
Compute the sustainable growth rate using ROE at the beginning:
Hence, the sustainable growth rate is 24.64%.
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Chapter 3 Solutions
ESSENTIALS OF CORPORATE FINANCE (LL)
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