A firm reported a profit margin of 8.5%, total asset turnover of 0.85 times, debt-to-equity ratio of 0.90 times, net income of $550,000, and dividends paid to common stockholders of $100,000. The firm has no preferred stock outstanding. What is the firm's internal growth rate?
A) 3.61%
B) 6.29%
C) 5.91%
D) 11.04%

Question

Quizplus · Accepted Answer

Internal growth rate can be calculated using the following formula:
Internal Growth Rate = (ROA x retention rate)/(1 - ROA x retention rate)

where,
ROA = Net Income / Total Assets
Retention Rate = Retained Earnings / Net Income
  
In this case,
ROA = 0.085 x 0.85 = 0.07225
Retention Rate = (Net Income - Dividends) / Net Income = (550,000 - 100,000) / 550,000 = 0.818

Substituting the values in the formula, we get:
Internal Growth Rate = (0.07225 x 0.818) / (1 - 0.07225 x 0.818) = 0.0629 or 6.29%

Therefore, the best choice is B, which is the calculated internal growth rate of 6.29%.

A Firm Reported a Profit Margin of 8