Sustainable Growth Rate Assumptions

What’s the assumption behind the sustainable growth rate?

For instance, one of the questions asks: Stack notices that Armishaw assumes a sustainable growth rate of 5% following the period of high growth. Stack asks Armishaw if it is true that the sustainable growth model assumes the company will require:

  1. external debt financing,
  2. external equity financing, and
  3. improving return on equity

I thought it was none of the above because I thought that in order to sustain growth you have to make sure of generating enough funds internally so that you don’t go out and ask for funding, but the answer was 1. How is that

If you have a positive sustainable growth rate then you don’t pay out 100% of your ROE in dividends. This means that your equity is growing. To maintain your capital structure, your liabilities have to grow at the same rate.