978-0077861704 Chapter 4 Case Solutions

CHAPTER 4

PLANNING FOR GROWTH AT S&S AIR

1. To calculate the internal growth rate, we first need to find the ROA and the retention ratio, so:

ROA = NI / TA

b = Addition to RE / NI

Now we can use the internal growth rate equation to get:

Internal growth rate = (ROA × b) / [1 – (ROA × b)]

To find the sustainable growth rate, we need the ROE, which is:

ROE = NI / TE

Using the retention ratio we previously calculated, the sustainable growth rate is:

The internal growth rate is the growth rate the company can achieve with no outside financing of any

CHAPTER 4 C-2

2. Pro forma financial statements for next year at a 12 percent growth rate are:

Income Statement

Sales $ 45,090,338

COGS 32,856,820

Other expenses 5,717,712

Balance Sheet

Assets Liabilities and Equity

Current assets Current liabilities

Cash $ 511,207 Accounts payable $ 1,040,486

Fixed assets

Net PP&E $ 19,850,242 Shareholder equity

Common stock $ 400,000

So, the EFN is:

EFN = Total assets – Total liabilities and equity

The company can grow at this rate by changing the way it operates. For example, if profit margin

increases, say by reducing costs, the ROE increases, thereby increasing the sustainable growth rate.

CHAPTER 4 C-3

3. Now we are assuming the company can only build in amounts of $5 million. We will assume that the

company will go ahead with the fixed asset acquisition. To estimate the new depreciation charge, we

Depreciation percentage = $1,804,220 / $17,723,430

The new level of fixed assets with the $5 million purchase will be:

So, the pro forma depreciation will be:

We will use this amount in the pro forma income statement. So, the pro forma income statement will

be:

Income Statement

Sales $ 45,090,338

COGS 32,856,820

Other expenses 5,717,712

CHAPTER 4 C-4

The pro forma balance sheet will remain the same except for the fixed asset and equity accounts. The

fixed asset account will increase by $5 million, rather than the growth rate of sales.