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"Financial Report":Sustainable growth rate
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Questions 1:
Which of the following ratios will most likely result in an increase in a company’s sustainable growth rate?
A 、Higher dividend payout
B、 Higher tax burden
C、 Lower interest burden
Questions 2:
The following information is given about a company:
What is the most appropriate conclusion an analyst can make about the solvency of the company? Solvency has:
A 、improved because the debt-to-equity ratio decreased.
B 、improved because the fixed charge coverage ratio increased.
C 、deteriorated because the debt-to-equity ratio increased.
View answer resolution
【Answer to question 1】B
【analysis】
B is correct. Sustainable growth rate = Retention ratio × ROE The higher a company’s return on equity (ROE) and its ability to finance itself from internally generated funds (a higher retention ratio), the greater its sustainable growth rate. In the five-factor ROE, any factor that increases ROE will increase sustainable growth: ROE = Tax burden × Interest burden × Earnings before interest and taxes margin × Asset turnover × Leverage A higher tax burden ratio (Net income/Earnings before tax) implies that the company can keep a higher percentage of pre-tax profits; this result implies a lower tax rate and a higher ROE.
A is incorrect. Higher retention (lower payout) increases sustainable growth.
C is incorrect. Lower interest burden means that the company has high borrowing costs, reducing pre-tax income relative to EBIT and reducing ROE and sustainable growth.
【Answer to question 2】A
【analysis】
A is correct. The debt-to-equity ratio decreased, thereby improving solvency; the fixed charge ratio remained the same.
B is incorrect. The fixed charge coverage stays the same
C is incorrect. From table above, it was shown that the solvency improved since D/E decreased. But if the candidate incorrectly uses only LTD in the ratio, the ratio does increase. See table below
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