Kidwell Industries has equity capital of $12 million total debt of $8 million and sales last year

QUESTION

Kidwell Industries has equity capital of $12 million, total debt of $8 million, and sales last year of $30 million.a. It has a target assets-to-sales ratio of 0.6667, a target net profit margin of 0.04, a target debt-to-equity ratio of 0.6667, and a target earnings retention rate of 0.75. In steady state, what is its sustainable growth rate?b. Suppose the company has established for next year a target assets-to-sales ratio of 0.62, a target net profit margin of 0.05, and a target debt-to-equity ratio of 0.80. It wishes to pay an annual dividend of $0.3 million and raise $1 million in equity capital next year. What is its sustainable growth rate for next year? Why does it differ from that in Part (a)?
Answer to part A : sustainable growth rate= SGR SGR = Retention rate *Net Profit margin * (1+debt equity ratio) / Total Asset to sales ratio less (Retention rate *Net Profit margin *(1+debt equity ratio) SGR = 0.75*0.04*(1+0.66667)/0.6667-(0.75*0.04*(1+0.6667) SGR = 8.11% Answer to part B: SGR = (Equity at start add New Equity less Dividend)(1+ Debt Equity Ratio)(1/Assets to sales ratio)/(1-(Net Profit Margin *(1+debt equity ratio)*(1/Assets to sales

io)*(1/Sales at start)-1 SGR = (12+1-0.3)*(1+0.80)*(1/0.62)/(1-(0.05*(1+0.80)*(1/0.62)*[1/30]-1 SGR = 43.77% Relatively higher profitability and a higher debt ratio, increases the Sustainable Growth Rate. In the present case, net profit margin and debt to equity has increased the Sustainable Growth Rate.

ANSWER:

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