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Once the sustainable growth rate is calculated, then it should be compared to the firm's actual growth rate. If sustainable growth is greater than actual growth, the firm might be underperforming. If the actual growth rate is greater than sustainable growth, the company may run into trouble because of unrestrained growth.
Example:
Assume the following information:
| Year |
1993 |
1994 |
1995 |
1996 |
1997 |
| NPM |
5% |
5.25% |
5.12% |
5.35% |
6.17% |
| Asset T/O |
.787 |
.793 |
.712 |
.774 |
.712 |
| Debt |
1.12 |
1.8 |
1.2 |
1.17 |
1.18 |
| Dividends |
$100,000 |
$100,000 |
$100,000 |
$100,000 |
$100,000 |
| Net Income |
$200,000 |
$250,000 |
$300,000 |
$350,000 |
$385,000 |
The Dividend Payout Ratio is calculated by dividing Dividends by Net Income.
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The Retention Ratio is 1 – Dividend Payout Ratio.
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Therefore the Dividend Ratio for 1994 is 40%, so the Retention Ratio is 60%.
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For that year then, the ROA would be 7.49% (5.25% × 7.93 × 1.8).
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The Sustainable Growth Rate would be 4.49%. (.6 × 7.49%).
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