 # Sustainable Growth Rate Question

Regarding Financial Statement Analysis, Pg 329, Q6 of Schweser L1 2008… Would the depth required to answer this question be typical of Level 1? It looks easy at a glance but the answer contains a combination of about 7 formulae! …or is there an easier way to get the answer?! Also, does anyone have any further information on “Equity Multiplier”? Famous Inc Fin. Statements: Sales: 800,000 Net Profit Margin: 20% Sales to Assets: 50% Equity Multiplier: 1.6 Int. Expense: 30,000 Div’s Declared: 32,000 What is the sustainable growth rate closest to? a. 3.2 b. 8.0 c. 16.0 d. 12.8

This is very indicative to a Level I exam question. sustained growth rate = ROE * RR ROE = NI/TE = NI/Sales * Sales/Assets * Assets/TE plug and chug, you’ll have to familiarize yourself with terms as well (eg Assets/TE is also called the Equity Multiplier) ROE = 0.20 * 0.50 * 1.6 = 0.16 RR = 1 - div payout ratio = 1 - 0.20 = 0.80 therefore sustained growth rate = 0.16 * 0.80 = 0.128 or 12.8% choice (d)

sorry, i was quick to answer the question but realized without further explanation someone struggling with the question might not find the answer above helpful, at least without a few additional details ROE = return on equity RR = earnings retention rate NI = net income = sales * net profit margin TE = total equity div payout ratio = div payment/ NI = 32,000/ (20% * 800,000) hope this helps

Char-Lee explained it correctly; the answer is (d). I would suggest knowing the DuPont analysis by heart, at least the 3 factor model.

For reference 3 Factor model: ROE = NI / CE = NI/NS * NS/TA * TA/CE = Net Profit Margin * Total Asset Turnover * Financial Leverage NS = Net Sales, TA=Total Assets, CE = Common Equity T=Tax Rate, EBIT=Earnings before Interest and taxes 5 Factor (Extended Model) NI / TA * TA / CE = (EBIT - Int )(1-T)/TA * TA / CE = (EBIT/TA - Int / TA) * (1-T) * TA / CE = [(EBIT/NS * NS / TA) - Int/TA] * TA/CE * (1-T) = [(Operating Profit Margin * Total Asset Turnover) - Interest Expense Ratio] * Financial Leverage * Tax Retention Hope this helps CP

i’d suggest using 3 factor model if possible because it’s faster (by the way EquityMultiplier is the same as FinancialLeverage) ROE = ProfitMargin*AssetTurnover*EquityMultiplier = 0.2*0.5*1.6 = 16% RR = (NetProfit - DivPaid)/NetProfit = (0.2*800 - 32)/(0.2*800) = 0.8 g = ROE*RR = 16%*0.8 = 12.8% -> D

That’s great, thanks for you help everyone!