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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:
Sustainable growth rate = (ROE × b)/[1 – (ROE × b)]
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 $51,853,889
COGS 38,681,343
Balance Sheet
Assets Liabilities and Equity
Current assets Current liabilities
Cash $587,959 Accounts payable $1,196,559
Fixed assets
Net PP&E $22,827,778 Shareholder equity
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
will find the current depreciation as a percentage of fixed assets, then, apply this percentage to the
new fixed assets. The depreciation as a percentage of assets this year was:
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 $51,853,889
COGS 38,681,343
Other expenses 6,575,369
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.
Balance Sheet
Assets Liabilities and Equity
Current assets Current liabilities
Cash $587,959 Accounts payable $1,196,559
Fixed assets
So, the EFN is:
EFN = Total assets – Total liabilities and equity
Since the fixed assets have increased at a faster percentage than sales, the capacity utilization for
next year will decrease.
