Skip to main content

What is Sustainable Growth Rate?

Sustainable Growth Rate:
It shows the maximum growth rate a company can achieve without increasing or changing the debt and asset amount. It can be negative or positive. The negative rate shows that the company must improve its debt equity ratio or you can say that the company have to increase its debt and assets amount.  A higher growth rate is better for the company. If company wants to increase the growth rate then they have to increase their debt and assets amount.
Formula:
Sustainable Growth R ate (SGR) = Retention rate* Return on equity rate
Retention rate: The rate of profit that reinvested in a company for company’s future growth is known as retention rate. Company pays dividend to its shareholders out of profit. It reinvested the remaining amount left after paying dividend to its shareholders for further expansion of a company. Higher rate shows more amounts are reinvested in a company in comparison to the amount pays to its shareholders. And the lower rate shows more amount uses to pay dividend to its shareholders in comparison to amount reinvested in a company.
Retention rate = (Net income – Dividend) / Net income
Or
Retention rate = 1- dividend payout rate
Or
Retention rate = (Earning per share – Dividend per share) / Earning per share) *100
Return on equity rate: It is the rate which shows how much profit earn by company from capital employed in a company. Higher the return on equity rate better for the company.
Return on Equity = Net income / Shareholders equity
Example: Find out the sustainable growth rate with the help of below information:
Particulars
Amount (in %)
Retention rate
0.25
Return on equity
60
Solution:
Sustainable Growth R ate (SGR) = Retention rate* Return on equity rate
SGR =0. 25*60
= 15%
Example: ABC Company has net income of Rs. 60,562. Company has decided to pay the dividend 0.30% to its shareholders. The operating expenses are Rs. 26,560. And the total assets of a company are Rs. 14, 20,650. Find out the sustainable growth rate if the total liabilities are Rs. 8, 65,200.
Solution: Shareholder’s equity = total assets – total liabilities
= Rs. (14, 20,650-8, 65,200)
=Rs. 5, 55, 450
 Return on Equity = Net income / Shareholders equity
= 60, 562 / 5, 55, 450
= 10.90%
Retention rate = 1- dividend payout rate
= 1- 0.30
= 0.70%
Sustainable Growth R ate (SGR) = Retention rate* Return on equity rate
= 0.70*10.90
= 7.63%
Company can grow maximum 7.63% without changing financial leverage.
Example: There are three food manufacturing companies PQR, ABC and XYZ find out the higher sustainable growth rate with the help of given information:
Particulars
PQR
ABC
XYZ
Net income
58, 260
57,890
59,800
Total equity
6,00,000
6,10,000
5, 89, 000
Dividend
20,000
30,000
25,000
 Solution:
Particulars
PQR
ABC
XYZ
Retention rate =
(Net income – Dividend) / Net income
(58, 260 – 20,000) / 58, 260
= 65%
(57,890 – 30, 000) / 57, 890
= 48%
(59,800-25, 000) / 59, 800
= 58%
Return on equity=
Net income / Shareholders equity
58, 260/6,00,000
= 9.71
57, 890/6,10,000
= 9.4
59, 800/5, 89, 000
= 10.15
Sustainable Growth rate                                
65*9.71
= 6.3
48*9.4
=4.5
58*10.15
= 5.88
PQR Company has higher growth rate in comparison to ABC and XYZ Company. It means PQR Company uses its internal finance efficiently to earn sufficient income without increasing debt and equity fund.

Comments

Post a Comment

Popular posts from this blog

How to calculate Cost of Preference Share Capital?

Cost of Preference Share Capital:  An amount paid by company as dividend to preference shareholder is known as Cost of Preference Share Capital. Preference share is a small unit of a company’s capital which bears fixed rate of dividend and holder of it gets dividend when company earn profit. Dividend payable is not a tax deductible amount. So, there is no tax adjustments required for comparing with cost of debt. Formula for Cost of Preference Share: Irredeemable Preference Share Redeemable Preference Share K p  = Dp/NP K p  = D p +((RV-NP)/n )/ (RV+NP)/2 Where, K p  = Cost of Preference Share D p  = Dividend on preference share NP = Net proceeds from issue of preference share (Issue price – Flotation cost) RV = Redemption Value N = Period of preference share Example:  A company issues 20,000 irredeemable preference share at 8% whose face value is Rs.50 each at 4% discount. Find out the Cost of Preference Share Capital.
87 comments
Read more

What is the difference between Cheque book and Pass book?

 Cheque book is issued by bank in customers / account holder request. With the help of this book account holder can withdraw cash from his/her account. Bank does not charge any fee to issued cheque book to its customer. But afterward bank charges some amount for using bank facility like cheque book, Debit card etc.So, Automatic some definite amount deducted from customer bank account. Pass book is  also issued by bank to its customer. It helps to record all the bank related activity according to date that is withdrawal and deposit. It is recorded by bank but the book is kept by customer to know the current balance of  his /her account.  Point of difference Pass book Cheque book What is the meaning of pass book and cheque book? Passbook is a book in which all withdrawal and deposit against customer account is recorded.   Cheque book is a book of cheques which are used to withdrawal the money to bank account.
Post a Comment
Read more

How to calculate interest on Hire Purchase System?

Interest on hire purchase:  Interest is calculated on Cash value of goods not in instalment value which includes cash value of goods and interest amount. It is calculated on yearly, quarterly and yearly basis. Interest is not calculated on down payment which is paid at delivery of goods. Depreciation is also charged on the hire purchase goods at the end of financial year. The method applies for depreciation is based on the contract between the parties.   Example:  Company V purchased a machine of Rs.70, 000 and paid Rs.5, 000 as down payment. The interest charged @6% and 8% depreciation annually. The instalment value for each year is Rs. 10,000. Find out the interest amount for 5 years. Solution: Interest calculated on Rs. Interest Instalment Cash Value 65, 000 65, 000*0.06 = 3, 900 12, 500 8, 600 56, 400 56, 400*0.06 = 3, 384 12, 500 9, 116 47, 284 47, 284*0.06 = 2, 837 12, 500 9, 6
3 comments
Read more