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CHAPTER 4
LONG-TERM FINANCIAL PLANNING
AND GROWTH
Answers to Concepts Review and Critical Thinking Questions
1. The reason is that, ultimately, sales are the driving force behind a business. A firm’s assets,
3. The internal growth rate is greater than 15%, because at a 15% growth rate the negative EFN
5. Presumably not, but, of course, if the product had been much less popular, then a similar fate would
CHAPTER 4 - 2
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. It is important to remember that equity will not increase by the same percentage as the other assets. If
CHAPTER 4 - 3
2. Here we are given the dividend amount, so dividends paid is not a plug variable. If the company pays
Assuming costs and assets increase proportionally, the pro forma financial statements will look like
this:
CHAPTER 4 - 4
Assuming costs and assets increase proportionally, the pro forma financial statements will look like
this:
5. Assuming costs, current liabilities, and assets increase proportionally, the pro forma financial
statements will look like this:
CHAPTER 4 - 5
The payout ratio is 40 percent, so dividends will be:
6. To calculate the internal growth rate, we first need to calculate the ROA, which is:
7. To calculate the sustainable growth rate, we first need to calculate the ROE, which is:
CHAPTER 4 - 6
8. The maximum percentage sales increase is the sustainable growth rate. To calculate the sustainable
growth rate, we first need to calculate the ROE, which is:
9. Assuming costs vary with sales and a 20 percent increase in sales, the pro forma income statement
will look like this:
CHAPTER 4 - 7
10. Below is the balance sheet with the percentage of sales for each account on the balance sheet. Notes
payable, total current liabilities, long-term debt, and all equity accounts do not vary directly with
sales.
HEIR JORDAN CORPORATION
Balance Sheet
($) (%) ($) (%)
11. Assuming costs vary with sales and a 15 percent increase in sales, the pro forma income statement
will look like this:
The payout ratio is constant, so the dividends paid this year is the payout ratio from last year times
net income, or:
CHAPTER 4 - 8
The pro forma balance sheet will look like this:
HEIR JORDAN CORPORATION
Pro Forma Balance Sheet
12. We need to calculate the retention ratio to calculate the internal growth rate. The retention ratio is:
13. We need to calculate the retention ratio to calculate the sustainable growth rate. The retention ratio
is:
CHAPTER 4 - 9
14. We first must calculate the ROE to calculate the sustainable growth rate. To do this we must realize
two other relationships. The total asset turnover is the inverse of the capital intensity ratio, and the
equity multiplier is 1 + D/E. Using these relationships, we get:
15. We must first calculate the ROE using the DuPont ratio to calculate the sustainable growth rate. The
ROE is:
Intermediate
16. To determine full capacity sales, we divide the current sales by the capacity the company is currently
using, so:
CHAPTER 4 - 10
17. To find the new level of fixed assets, we need to find the current percentage of fixed assets to full
capacity sales. Doing so, we find:
18. We have all the variables to calculate ROE using the DuPont identity except the profit margin. If we
find ROE, we can solve the DuPont identity for profit margin. We can calculate ROE from the
sustainable growth rate equation. For this equation we need the retention ratio, so:
19. We are given the profit margin. Remember that:
CHAPTER 4 - 11
20. We should begin by calculating the D/E ratio. We calculate the D/E ratio as follows:
CHAPTER 4 - 12
21. To calculate the sustainable growth rate, we first must calculate the retention ratio and ROE. The
retention ratio is:
CHAPTER 4 - 13
22. Since the company issued no new equity, shareholders’ equity increased by retained earnings.
Retained earnings for the year were:
CHAPTER 4 - 14
23. The ROA using end of period assets is:
CHAPTER 4 - 15
24. Assuming costs vary with sales and a 20 percent increase in sales, the pro forma income statement
will look like this:
The pro forma balance sheet will look like this:
FLEURY INC.
Pro Forma Balance Sheet
Assets Liabilities and Owners’ Equity
