DISCUSSION

Question: Derive the sustainable growth equation

SUSTAINABLE GROWTH RATE
Sustainable Growth Rate = Earnings Retention Rate x ROE
 SUSTAINABLE GROWTH RATE
Sustainable growth rate = growth rate of shareholder’s equity
Sustainable growth rate = growth rate of shareholder’s equity

Increase in Retained Earnings

Growth rate of shareholder’s Equity =
Share holder’s Equity at Beginning year

Increase in Retained Earnings = Earnings Retention Rate x Net Income

Earning’s retention rate = 1- Dividend Payout Ratio – Share Repurchase Rate

Therefore:
Growth rate of shareholder’s Equity
Net Income
= Earning Retention Rate x
Share holder’s Equity
In Other Words:
Growth rate of Shareholder’s Equity = Earnings Retention Rate x ROE
Sustainable Growth Rate = Earnings Retention Rate x ROE
Sustainable growth rate = growth rate of shareholder’s equity

Increase in Retained Earnings

Growth rate of shareholder’s Equity =
Share holder’s Equity at Beginning year

Increase in Retained Earnings = Earnings Retention Rate x Net Income

Earning’s retention rate = 1- Dividend Payout Ratio – Share Repurchase Rate

Therefore:
Growth rate of shareholder’s Equity
Net Income
= Earning Retention Rate x
Share holder’s Equity
In Other Words:
Growth rate of Shareholder’s Equity = Earnings Retention Rate x ROE
Sustainable Growth Rate = Earnings Retention Rate x ROE
 DISCUSSION
Last year sales were $1 million. This means that assets were $2
million, and debt and shareholder’s equity were $1 million each.
Because ROE was 20%, net income must have been $200,000 of
which $80,000 was paid out of dividends and $120,000 retained as
new sales by as much as $120,000.
Assets Turnover= 0.5 Time per Year
Debt/Equity Ratio= 1.0
Dividend Payout Ratio= 0.4
ROE= 20% per Year

Question: Critically analyze and complete the sustainable growth

The financial statements of Rapid Industries for three years of
sustainable growth are shown in the table:
Income 20x1 20x2 20x3
Statements
Sale $1,000,000 $1,120,000 $1,254,400
Net Income 200,000 224,000 250,880
Dividends 80,000 89,600 100,352
Increase in 120,000 134,400 150,528
Retained
Earnings

Balance 20x1 20x2 20x3 20x4

Sheets
Assets $2,000,000 $2,240,000 $2,508,800 $2,809,856
Debt 1,000,000 1,120,000 1,254,400 1,404,928
Equity 1,000,000 1,120,000 1,254,400 1,404,928
Economic Value Added (EVA) is a financial
performance method to calculate the true economic
profit of a corporation.
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔 − 𝒐𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔
𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑷𝒓𝒐𝒇𝒊𝒕 (𝑬𝑩𝑰𝑻)

− 𝒕𝒂𝒙𝒆𝒔
𝑵𝒆𝒕 𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑷𝒓𝒐𝒇𝒊𝒕 𝑨𝒇𝒕𝒆𝒓 𝑻𝒂𝒙 (𝑵𝑶𝑷𝑨𝑻)

−𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑪𝒉𝒂𝒓𝒈𝒆𝒔 (𝑰𝒏𝒗𝒆𝒔𝒕𝒆𝒅 𝑪𝒂𝒑𝒊𝒕𝒂𝒍 % 𝑪𝒐𝒔𝒕 𝒐𝒇 𝑪𝒂𝒑𝒊𝒕𝒂𝒍)

𝑬𝒄𝒐𝒏𝒐𝒎𝒊𝒄 𝑽𝒂𝒍𝒖𝒆 𝒂𝒅𝒅𝒆𝒅 (𝑬𝑽𝑨)
■ EVA is an estimate of the amount by which earnings exceed or fall short of
the required minimum rate of return for shareholders or lenders at
comparable risk

■ Unlike market-based measures, such as Market Value Added (MVA), EVA can
be calculated at divisional (Strategic Business Unit) levels.

■ unlike stock measures, EVA is a flow and can be used for performance
evaluation over a certain period.

■ Unlike accounting profit, such as Earnings Before Interest and Tax (EBIT), Net
Income and Earnings per Share (EPS), EVA is economic. EVA is based on the
concept of businesses having to cover both operating costs and capital costs.
Some specific uses of EVA include:
■ To set organizational goals
■ Performance measurement
■ Determining of bonuses
■ Communication with shareholders and investors
■ Motivation of managers
■ Capital budgeting
■ Corporate valuation
■ Analyzing equities
 DISCUSSION
BALANCE SHEET, INCOME STATEMENT, CASH FLOW
The Ruffy Stuffed Toy Company’s balance sheet at the end of 19x7 was as follows:
Assets
Cash 27,300
Accounts Receivable 35,000
Inventory 57,000
Total Current Assets 119,300
Property, Plant, and Equipment
Equipment 25,000
Less Accumulated Depreciation <2,500>
Net Equipment 22,500
Furniture 16,000
Less Accumulated Depreciation <2,000>
Net Furniture 14,000
Total Prop, Plant, Equip 36,500
Total Assets 155,800
Liabilities and Shareholders’ Equity
Payables
Accounts Payable 65,000
Salary Payable 3,000
Utilities Payable 1,500
Loans (Long-term debt) 25,000
Total Liabilities 94,500
Common Stock 45,000
Retained Earnings 16,300
Total Shareholders’ Equity 61,300
Total Liabilities & Shareholders’ Equity 155,800
 BALANCE SHEET
20x1 20x2
Assets
Cash 27,300
Accounts Receivable 35,000
Inventory 57,000
Total Current Assets 119,300

Property, Plant, and Equipment

Equipment 25,000
Less Accumulated Depreciation <2,500>
Net Equipment 22,500
Furniture 16,000
Less Accumulated Depreciation <2,000>
Net Furniture 14,000
Machine
Less Accumulated Depreciation
NET Machine

Total Prop, Plant, Equip 36,500

Total Assets 155,800

Liabilities and Shareholders’ Equity

Payables
Accounts Payable 65,000
Salary Payable 3,000
Utilities Payable 1,500
Loans (Long-term debt) 25,000
Total Liabilities 94,500
Common Stock 45,000
Retained Earnings 16,300
Total Shareholders’ Equity 61,300
Total Liabilities & Shareholders’ Equity 155,800
During 20x2, the Ruffy Stuffed Toy Company
recorded the following transactions:
a. Early in the year, purchased a new toy stuffing
machine for $9,000 cash and signed a 3-year note
for the balance of $12,000.
b. Had cash sales of $115,000 and sales on credit of
$316,000
c. Purchased raw materials from suppliers for
$207,000.
d. Made payments of $225,000 to its raw materials
suppliers.
e. Paid rent expenses totaling $43,000.
f. Paid insurance expenses totaling $23,000.
g. Paid utility bills totaling $7,500; $1,500 of this
amount reversed the existing payable from 20x1
h. Paid wages and salaries totaling $79,000; $3,000 of
this amount reversed the payable from 20x1
i. Paid other miscellaneous operating expenses
totaling $4,000.
j. Collected $270,000 from its customers who made
purchases on credit.
k. The interest rate on the Loan Payable is 10% per
year. Interest was paid on 12/31/20x2
Other information:
1. The equipment has been estimated to have a useful
life of 20 years, with no salvage value. Two years have
been depreciated through 20x1
2. The existing furniture has been estimated to have a
useful life of 8 years (no salvage value), of which one
year has been depreciated through 20x1
3. The new stuffing machine has been estimated to have
a useful life of 7 years, and will probably have no
salvage value.
4. The tax rate is 35%, and assume that taxes are paid on
12/31/20x2
5. Dividend payout, if possible, will be 10% of net income.
6. Cost of Goods Sold for the year’s sales were
$250,000.
7. Ending Balance in accounts receivable = Beginning
Balance − cash received from credit customers + sales
on credit
8. Ending Balance in accounts payable =Beginning
Balance + purchases – cash payments to suppliers
9. Ending Balance in Inventory =Beginning Balance +
purchases of raw material – cost of goods sold
10. The company’s stock price at market close on
12/31/20x2 was 4 5/8. It has 20,000 shares
outstanding.
During 20x2, the Ruffy Stuffed Toy Company
recorded the following transactions:
a. Early in the year, purchased a new toy stuffing
machine for $9,000 cash and signed a 3-year note
for the balance of $12,000.
b. Had cash sales of $115,000 and sales on credit of
$316,000
c. Purchased raw materials from suppliers for
$207,000.
d. Made payments of $225,000 to its raw materials
suppliers.
e. Paid rent expenses totaling $43,000.
f. Paid insurance expenses totaling $23,000.
g. Paid utility bills totaling $7,500; $1,500 of this
amount reversed the existing payable from 20x1
h. Paid wages and salaries totaling $79,000; $3,000 of
this amount reversed the payable from 20x1
i. Paid other miscellaneous operating expenses
totaling $4,000.
j. Collected $270,000 from its customers who made
purchases on credit.
k. The interest rate on the Loan Payable is 10% per
year. Interest was paid on 12/31/20x2
Other information:
1. The equipment has been estimated to have a useful
life of 20 years, with no salvage value. Two years have
been depreciated through 20x1
2. The existing furniture has been estimated to have a
useful life of 8 years (no salvage value), of which one
year has been depreciated through 20x1
3. The new stuffing machine has been estimated to have
a useful life of 7 years, and will probably have no
salvage value.
4. The tax rate is 35%, and assume that taxes are paid on
12/31/20x2
5. Dividend payout, if possible, will be 10% of net income.
6. Cost of Goods Sold for the year’s sales were
$250,000.
7. Ending Balance in accounts receivable = Beginning
Balance − cash received from credit customers + sales
on credit
8. Ending Balance in accounts payable =Beginning
Balance + purchases – cash payments to suppliers
9. Ending Balance in Inventory =Beginning Balance +
purchases of raw material – cost of goods sold
10. The company’s stock price at market close on
12/31/20x2 was 4 5/8. It has 20,000 shares
outstanding.
 BALANCE SHEET
a. Early in the year,
20x1 20x2
purchased a new toy
Assets
stuffing machine for Cash 27,300
$9,000 cash and signed Accounts Receivable 35,000
Inventory 57,000
a 3-year note for the Total Current Assets 119,300
balance of $12,000.
Property, Plant, and Equipment
1. The equipment has been Equipment 25,000 25,000
Less Accumulated Depreciation <2,500> <3,750>
estimated to have a useful life Net Equipment 22,500 21,250
of 20 years, with no salvage Furniture 16,000 16,000
Less Accumulated Depreciation <2,000> <4,000>
value. Two years have been Net Furniture 14,000 12,000
depreciated through 20x1 Machine 21,000
Less Accumulated Depreciation <3,000>
2. The existing furniture has NET Machine 18,000
been estimated to have a
useful life of 8 years (no Total Prop, Plant, Equip 36,500 51,250
salvage value), of which one Total Assets 155,800

year has been depreciated Liabilities and Shareholders’ Equity

through 20x1 Payables
Accounts Payable 65,000
3. The new stuffing machine has Salary Payable 3,000
been estimated to have a Utilities Payable 1,500
Loans (Long-term debt) 25,000
useful life of 7 years, and will Total Liabilities 94,500
probably have no salvage Common Stock 45,000
Retained Earnings 16,300
value. Total Shareholders’ Equity 61,300
 BALANCE SHEET
a. Early in the year,
20x1 20x2
purchased a new toy
Assets
stuffing machine for Cash 27,300
$9,000 cash and signed Accounts Receivable 35,000
Inventory 57,000
a 3-year note for the Total Current Assets 119,300
balance of $12,000.
Property, Plant, and Equipment
1. The equipment has been Equipment 25,000 25,000
Less Accumulated Depreciation <2,500> <3,750>
estimated to have a useful life Net Equipment 22,500 21,250
of 20 years, with no salvage Furniture 16,000 16,000
Less Accumulated Depreciation <2,000> <4,000>
value. Two years have been Net Furniture 14,000 12,000
depreciated through 20x1 Machine 21,000
Less Accumulated Depreciation <3,000>
2. The existing furniture has NET Machine 18,000
been estimated to have a
useful life of 8 years (no Total Prop, Plant, Equip 36,500 51,250
salvage value), of which one Total Assets 155,800

year has been depreciated Liabilities and Shareholders’ Equity

through 20x1 Payables
Accounts Payable 65,000
3. The new stuffing machine has Salary Payable 3,000
been estimated to have a Utilities Payable 1,500
Loans (Long-term debt) 25,000
useful life of 7 years, and will Total Liabilities 94,500
probably have no salvage Common Stock 45,000
Retained Earnings 16,300
value. Total Shareholders’ Equity 61,300
During 20x2, the Ruffy Stuffed Toy Company
recorded the following transactions:
a. Early in the year, purchased a new toy stuffing
machine for $9,000 cash and signed a 3-year note
for the balance of $12,000.
b. Had cash sales of $115,000 and sales on credit of
$316,000
c. Purchased raw materials from suppliers for
$207,000.
d. Made payments of $225,000 to its raw materials
suppliers.
e. Paid rent expenses totaling $43,000.
f. Paid insurance expenses totaling $23,000.
g. Paid utility bills totaling $7,500; $1,500 of this
amount reversed the existing payable from 20x1
h. Paid wages and salaries totaling $79,000; $3,000 of
this amount reversed the payable from 20x1
i. Paid other miscellaneous operating expenses
totaling $4,000.
j. Collected $270,000 from its customers who made
purchases on credit.
k. The interest rate on the Loan Payable is 10% per
year. Interest was paid on 12/31/20x2
Other information:
1. The equipment has been estimated to have a useful
life of 20 years, with no salvage value. Two years have
been depreciated through 20x1
2. The existing furniture has been estimated to have a
useful life of 8 years (no salvage value), of which one
year has been depreciated through 20x1
3. The new stuffing machine has been estimated to have
a useful life of 7 years, and will probably have no
salvage value.
4. The tax rate is 35%, and assume that taxes are paid on
12/31/20x2
5. Dividend payout, if possible, will be 10% of net income.
6. Cost of Goods Sold for the year’s sales were
$250,000.
7. Ending Balance in accounts receivable = Beginning
Balance − cash received from credit customers + sales
on credit
8. Ending Balance in accounts payable =Beginning
Balance + purchases – cash payments to suppliers
9. Ending Balance in Inventory =Beginning Balance +
purchases of raw material – cost of goods sold
10. The company’s stock price at market close on
12/31/20x2 was 4 5/8. It has 20,000 shares
outstanding.
 BALANCE SHEET
20x1 20x2
Assets
Cash 27,300 10,896.25
Accounts Receivable 35,000 81,000
Inventory 57,000 14,000
Total Current Assets 119,300 105,896.25

Property, Plant, and Equipment

Equipment 25,000 25,000
Less Accumulated Depreciation <2,500> <3,750>
Net Equipment 22,500 21,250
Furniture 16,000 16,000
Less Accumulated Depreciation <2,000> <4,000>
Net Furniture 14,000 12,000
Machine 21,000
Less Accumulated Depreciation <3,000>
NET Machine 18,000

Total Prop, Plant, Equip 36,500 51,250

Total Assets 155,800 157,146.25

Liabilities and Shareholders’ Equity

Payables
Accounts Payable 65,000 47,000
Salary Payable 3,000 0
Utilities Payable 1,500 12,000
Loans (Long-term debt) 25,000 25,000
Total Liabilities 94,500 84,000
Common Stock 45,000 45,000
Retained Earnings 16,300 28,146.25
Total Shareholders’ Equity 61,300 73,146.25
 BALANCE SHEET
20x1 20x2
Assets
Cash 27,300 10,896.25
Accounts Receivable 35,000 81,000
Inventory 57,000 14,000
Total Current Assets 119,300 105,896.25

Property, Plant, and Equipment

Equipment 25,000 25,000
Less Accumulated Depreciation <2,500> <3,750>
Net Equipment 22,500 21,250
Furniture 16,000 16,000
Less Accumulated Depreciation <2,000> <4,000>
Net Furniture 14,000 12,000
Machine 21,000
Less Accumulated Depreciation <3,000>
NET Machine 18,000

Total Prop, Plant, Equip 36,500 51,250

Total Assets 155,800 157,146.25

Liabilities and Shareholders’ Equity

Payables 47,000
Accounts Payable 65,000 0
Salary Payable 3,000 0
Utilities Payable 1,500 12,000
Loans (Long-term debt) 25,000 25,000
Total Liabilities 94,500 84,000
Common Stock 45,000 45,000
Retained Earnings 16,300 28,146.25
Total Shareholders’ Equity 61,300 73,146.25
Total Liabilities & Shareholders’ Equity 155,800 157,146.25
 INCOME STATEMENT
Sales Revenue 431,000
COGS 250,000 [
Gross Margin 181,000
Expenses
Wages and Salaries Expense 76,000
Rent Expense 43,000
Insurance Expense 23,000
Utility Expense 6,000
Miscellaneous Operating Expense 4,000
Depreciation Expense 6,250
TOTAL 181,000 158,250

Income Before Interest and Tax 22,750

Interest Expense 2,500
Taxable Income 20,250
Taxes (0.35) 7,087.50

Net Income 13,162.50

Dividends (0.1) 1,316.25

Income after Dividends 11,846.25

 CASH FLOW STATEMENT
Net Income 13,162.50
+Dep 6,250
- A/R increase 35,000 81,000 -46,000
+ Inventory decrease 57000 14,000 43,000
- A/P decrease 69500 47,000 -22,500
Total Cash Flow from Operations -6087.5
- Investment in PPE -21000
Total cash from investing activities -21000
- Dividends -1316.25
+ Increase in Notes Payable 12000
Total cash from financing activities 10683.75
Change in Cash Flow −16403.75

RATIOS:
ROS 22750 431000 0.0528
ROA 22750 156473.13 0.1454
ROE 13162.5 67223.13 0.1958
Receivables 431000 58000 7.431
Turnover
Inventory Turnover 250000 35500 7.0423
Asset Turnover 431000 156473.13 2.7545
Debt 84000 157146.25 0.5345
Times Interest Earned 22750 2500 9.1
Current 157146.25 84000 1.87
Quick 91,896.25 47000 1.9552
P/E 4.625 0.6581 7.0278
Mkt to Book 4.625 3.6573 1.2646