External Financing and Growth

EXTERNAL FINANCING AND GROWTH
Two growth rates used in financial planning:

1. Internal growth rate

- The maximum growth rate a firm can achieve without external financing of any kind (no debt or equity).

- This is the growth rate that the firm can maintain with internal financing only.

- The required increase in assets is exactly equal to the addition to retained earnings, and EFN is therefore zero.

IGR = ROA x Plowback ratio

1 – (ROA x Plowback ratio)

2. Sustainable growth rate

- The maximum growth rate a firm can achieve without external EQUITY financing while maintaining a constant debt-equity ratio.

- The firm can borrow, but must maintain its debt-equity ratio (no increase in financial leverage).

SGR = ROE x Plowback ratio

1 – (ROE x Plowback ratio)

Or SGR = m (1-d) A/E

A/S – m(1-d) A/E

Where m = profit margin

d = dividend payout ratio

A = assets

E = equity

S = sales

Illustrative problem:

|Income Statement (P) |Balance Sheet (P) |
|Sales |500 |Current assets |200 |
|Costs |400 |Net fixed assets |300 |
|Income before taxes |100 |Total assets |500 |
|Taxes (34%) |34 | | |
|Income after taxes |66 | | |