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Finace (IGR, SGR, EFN) - Case Study Example

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FINANCE Table of Contents Table of Contents 2 Background 3 Question 1: 4 Internal Growth Rate (IGR) 4 Sustainable Growth Rate (SGR) 5 Question 2: 6 External Financing Needed (EFN) 6 Question 3: 7 References 8 Appendices 9 Appendix 1 9 Appendix 2 11 Background S&S Air is a profitable public company…
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Finace (IGR, SGR, EFN)
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Finace (IGR, SGR, EFN)

The remaining income was added back as the retained earnings for the company. This type of retained earnings generally helps companies like S&S Air to provide for internal financing required for further investments in the company. However, in the past S&S Air did not have proper planning regarding the investment opportunities of the company. As a result of this, the company lost sales in the past and had to go through crunch situations as regards to the liquidity position of the company. Hence the company is requiring the need for proper planning for its future investments. Ratio analysis has been done to analyze the current financial condition of the company. Next utilizing the financial ratios calculated, the owners of the company is willing to have a proper financial planning of S&S Air in future. The company needs this type of planning to decide upon the forecasted sales next year which the company can expect to generate. Moreover it would also help the company to know whether any external financing is required to have the desired growth of the company next year. The company management also needs to have a proper idea about its current efficiency in utilizing its capacity so that improvements can be made if the capacity utilization of the company is less. Hence, calculating the internal growth rate and sustainable growth rate of the company along with the EFN, can help the company plan efficiently for the upcoming Fiscal Year 2012. Question 1: Calculate the internal growth rate and sustainable growth rate for S&S Air. What do these numbers mean? Answer: Internal Growth Rate (IGR) The internal growth rate of a company is given by the following formula (Ross, Westerfield, and Jordan 108): Internal Growth Rate = (ROA*b)/(1-ROA*b) Where, ROA = Return on Assets = Net Income/Total Assets b = Retention Ratio = (Addition to Retained Earnings/Net Income) Thus for S&S Air, ROA = 1,845,242/17,379,480 = 10.62% = 0.1062 b = (1,285,242/1,845,242) = 69.65% = 0.6965 (approx) Hence, the Internal Growth Rate for S&S Air is given by: Internal Growth Rate = (0.1062*0.6965)/(1-0.1062*0.6965) = 7.99 % This implies that S&S Air would be able to expand its business and grow at a rate of 7.99% per year without the need of any external financing. Sustainable Growth Rate (SGR) This growth rate gives a measure about the growth of a company utilizing its internal financial sources (Jones 383). It is given by the formula: Sustainable Growth Rate = (ROE * b)/(1-ROE*b) Where, ROE = Return on Equity = Net Income/Total Equity b = Retention Ratio Thus for S&S Air, ROE = 1845242/9556430 = 19.31% = 0.1931 b = 69.65% = 0.6965 Hence, the Sustainable Growth Rate for S & S Air is given by: Sustainable Growth Rate = (0.1931*0.6965) * (1 - (0.1931*0.6965)) = 15.54% This implies that S&S Air would be able to expand and grow at a rate of 15.54% per year without the need of any equity financing externally. Question 2: S&S Air is planning for a growth rate of 12 percent next year. Calculate the EFN for the company assuming the company is operating at full capacity. Can the company's sales increase at this growth rate? Answer: External Financing Needed (EFN) A company requires financing from external sources if it is unable to generate adequate cash flows required to fulfill its present financial obligations (Moles, Parrino, and Kidwell 756). The EFN for S&S Air is calculated using the pro forma statements which utilizes the approach related to percentage of ... Read More
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