The Sustainable Growth Rate

One ratio that is very helpful in financial analysis is called the sustainable growth rate. It is the maximum rate of growth a firm can maintain without increasing its financial leverage and using internal equity only. The precise value of sustainable growth can be calculated as

Sustainable growth rate = ROE X Retention ratio

For the U.S. Composite Company, ROE is 11.2 percent. The retention ratio is 1/2, so we can calculate the sustainable growth rate as

The U.S. Composite Corporation can expand at a maximum rate of 5.6 percent per year with no external equity financing or without increasing financial leverage. (We discuss sustainable growth in Chapters 5 and 26.)

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