If Rondolo, Inc. decides to maintain a constant debt-equity ratio, what rate of growth can they maintain?

Question

Quizplus · Accepted Answer

To determine the rate of growth, we need to use the internal growth rate formula:

Internal Growth Rate = (ROA - Dividend / (1 - Dividend)) * (1 - Debt-to-Equity Ratio)

ROA = 6.00%
Dividend = 0% (since it is not given, we assume it to be 0%)
Debt-to-Equity Ratio = 1.10

Substituting these values in the formula, we get:

Internal Growth Rate = (0.06 - 0 / (1 - 0)) * (1 - 1.10)
Internal Growth Rate = (-0.066)

Since the internal growth rate is negative, it means that the company cannot sustain any growth without raising external funds. Therefore, the answer should be greater than -6.6%, giving us options D and E.

Now, let's calculate the sustainable growth rate using the formula:

Sustainable Growth Rate = (ROE - Dividend / (1 - Dividend)) * (1 - Debt-to-Equity Ratio)

ROE = ROA * (1 - Debt-to-Equity Ratio) = 6% * (1 - 1.1) = -6%
Dividend = 0%

Substituting these values in the formula, we get:

Sustainable Growth Rate = (-0.06 - 0 / (1 - 0)) * (1 - 1.1)
Sustainable Growth Rate = 0.024 = 2.4%

Therefore, the best answer is D) 8.24%, which is greater than the internal growth rate and sustainable growth rate.