1. TOPIC: ESTIMATING SUSTAINABLE SALES GROWTH RATES
Question: At what Percentage Rate can a Firm’s Sales Grow before It Needs to Issue New Common Stock, Assuming no Change in Operating Performance and Financial Policies?
RW Melicher Ibanking 2013

2. A. Why is Sales Growth Important?
Higher growth rates allow for possible economies of scale in production and distribution
For commodity-type businesses, it is important to grow sales at least at the industry average to maintain market share
Firm value will be increased if higher growth rates result in higher profits and larger free cash flows

3. B. Basic Concept Sustainable sales growth rate (g):
Rate at which a firm can grow based on the retention
of its profits in the business. In other words, a firm
can grow its sales at the rate it increases its equity on
a percentage basis each year
g = Change in Equity/Beginning Equity
where: Change in Equity is: (Ending Equity –
Beginning Equity

4. C. Sustainable Sales Growth
Assumptions:
a constant operating performance, a target capital
structure, a target dividend policy, and no new
stock sales]
Change in Equity = Net Income (NI) x Retention Rate (RR)
where: RR is the proportion of net income
retained in the firm
g = (NI/Beginning Equity) x RR

5. D. Sustainable Sales Growth Rate Model
Putting It Together:
g = Operating Performance x Financial Policies
Where:
Operating Performance = Net Income/Net Sales x Net
Sales/Total Assets
Financial Policies = Total Assets/Beginning Equity x (Net
Income – Dividends)/Net Income
Alternatively, g = Profit Margin x Assets Turnover x Beginning Equity Multiplier x Retention Rate

7. E. Three Sales Growth Scenarios
Actual Growth = Sustainable Growth cash sources and uses are in balance
Actual Growth > Sustainable Growth
--cash deficits
Actual Growth < Sustainable Growth
--cash surpluses

8. F. Choices when Actual Growth Exceeds Sustainable Growth
Sell New Equity
Increase Financial Leverage
Reduce the Dividend Payout Ratio
Restructure Assets (sell marginal operations [focus on core businesses] and/or out-source selected activities)
Explore Price-Volume Relationships
Merge (find a partner with excess funds)

9. G. Choices when Sustainable Growth Exceeds Actual Growth
Conduct Business as Usual (BAU)
[Potential problems include excess cash and/or poor
investment decisions]
Return Excess Cash to Shareholders
[Increase dividends and/or repurchase shares]
Acquire Growth
[Evidence suggests that “benefits” from merging
high-growth and low-growth firms are suspect]