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Gilmore, Inc
Gilmore, Inc., had equity of $130,000 at the beginning of the year. At the end of the year, the company had total assets of $285,000. During the year, the company sold no new equity. Net Income for the year was $28,000 and dividends were $3,200. a. What is the sustainable growth rate for the company? (Do not round Intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the sustainable growth rate if you use the formula ROE band beginning of perlod equity? (Do not round Intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) c. What is the sustainable growth rate if you use end of period equity in this formula? (Do not round Intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) a. 96 b. Sustainable growth rate ROE x b (using beginning of period equity) ROE x b (using end of period equity) 96 c. 96
Quad Enterprises is considering a new three-year expansion project that requires an Initial fixed asset Investment of $2.31 million. The fixed asset will be depreciated straight- line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $1,657,000 in annual sales, with costs of $633,000. If the tax rate Is 25 percent, what is the OCF for this project? (Do not round Intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) OCF
Expert Solution
Answer :
(a.) Calculation of Sustainable growth rate :
Sustainable Growth Rate = [Retention on Equity * retention ratio] / [1 - (Return on equity * retention ratio)]
Beginning of period Equity = $130,000
End of Period Equity = 130,000 + Addition of Retained Earning
= 130000 + Net Income - Dividend
= 130,000 + 28000 - 3200
= 154800
Return on Equity = Net Income / End of Period Equity
= 28000 / 154800
= 0.18087855297 or 18.087855297%
Retention ratio = (Net Income - Dividend ) / Net income
= (28000 - 3200) / 28000
= 0.88571428571 or 88.571428571%
Sustainable Growth Rate = [0.18087855297 * 0.88571428571 ] / [1 - (0.18087855297 * 0.88571428571)]
= 0.16020671834 / [1 - 0.16020671834]
= 0.16020671834 / 0.83979328166
= 0.1908 or 19.08%
(b.) Calculation of the sustainable growth rate if you use the formula ROE x b and beginning of period equity
Return on Equity = Net Income / Beginning of Period Equity
= 28000 / 130,000
=0.21538461538 or 21.54%
Retention ratio = (Net Income - Dividend ) / Net income
= (28000 - 3200) / 28000
= 0.88571428571 or 88.571428571%
Sustainable growth rate = Return on Equity * Retention ratio
= 0.21538 * 0.8857
= 0.1908 or 19.08%
(c.) Calculation of sustainable growth rate if you use end of period equity in this formula :
Return on Equity = Net Income / End of Period Equity
= 28000 / 154800
= 0.18087855297 or 18.087855297%
End of Period Equity = 130,000 + Addition of Retained Earning
= 130000 + Net Income - Dividend
= 130,000 + 28000 - 3200
= 154800
Retention ratio = (Net Income - Dividend ) / Net income
= (28000 - 3200) / 28000
= 0.88571428571 or 88.571428571%
Sustainable growth rate = Return on Equity * Retention ratio
= 0.18088 * 0.8857
=16.02%
Answer :2) Calculation of OCF
OCF = [(Annual Sales - Annual Cost - Depreciation) * (1 - Tax rate)] + Depreciation
Depreciation to be charged each year = Initial Investment / Number of year of useful Life
= 2,310,000 / 3
= 770,000
OCF = [(1657000 - 633000 - 770000) * (1 - 0.25)] + 770000
= 190500 + 770000
= 960500
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