SUSTAINABLE GROWTH RATE

Meaning – Sustainable growth rate of a firm is the maximum rate of growth in sales that can be achieved,
given the firm’s profitability, asset utilization, desired dividend payout ratio and debt (financial leverage)
ratios.

Assumptions of the model:

(i) Assets of the firm will increase proportionally to sales.
(ii) Net profit is a constant proportion of sales.
(iii) Business wants to maintain a target capital structure without issuing new equity.
(iv) Dividend pay – out ratio and debt – equity ratio of the firm are given.
(v) Business wants to maintain a target dividend payment ratio.
(vi) Increase sales as rapidly as market conditions allow.

Computation of SGR:

SGR (g) = ROE (1 – Dividend payout ratio) SGR =

Earningsafter tax Netmargin∗Retention∗Assets
Where ROE = Equity
Net worth
Netmargin∗Retention∗Assets
Assettosales−[ ]
Equity
OR

Increaseinassets
SGR =
Assetsatyearend −increaseinassets

OR

m(1−d) A / E
SGR = A
−m ( 1−d ) A / E
S0

Where,
m = Net profit margin ratio
d = Dividend payout ratio
A = Total assets
E = Equity / Net worth
S0 = Current sales
HOW TO PREPARE INCOME STATEMENT
Particulars `
Sales xxx
Less: Operating costs (xxx)
Operating profit / EBIT xxx
 Less: Interest (xxx)
Earnings before tax / PBT xxx
Less: Tax @ …. % (xxx)
Profit after tax xxx
Less: Dividend (xxx)
Retained earnings xxx

SOME OTHER RATIOS:

(1) Return on Investment (ROI) / Return on capital employed (ROCE)
EBIT
ROI / ROCE =
Total capital employed

OR
EBIT (1−T )
ROI / ROCE =
Total capital employed

Note: Bothe equations are correct. Students can use any equation in exam.
Decision: Higher the better.

Net sales
(2) Asset turnover ratio (ATR) =
Total assets

Note: Total asset does not include fictitious assets.

Decision: Higher the better.

Debentures+ Long term loans+ Preference share capital

(3) Capital gearing ratio (CGR) =
Equity share holde r ' s fund
Decision: Lower the better.

Profit after tax+ Interest

(4) Fixed interest and fixed dividend coverage ratio =
interest + Preference dividend

Decision: Higher the better.

Question: 9 [CA – Nov. 09]

Following financial data are available for PQR Ltd. for the year 2011 (Rs. In lakhs)
8 % debentures 125
10 % bonds (2010) 50
Equity shares (Rs. 10 each) 100
Reserves and surplus 300
Total assets 600
Assets turnover ratio 1.1
Effective interest rate 8%
Effective tax rate 40 %
Operating margin 10 %
Dividend payout ratio 16.67 %
Current market price of shares 14
Required rate of return of investors 15 %
You are required to:
(i) Draw income statement for the year.
(ii) Calculate its sustainable growth rate
(iii) Calculate the fair price of the company’s share using dividend discount model, and
(iv) What is your opinion on investment in the company’s share at current price?

Question: 10 [CA – Nov. 2012]

Following are the financial data of Platinum Limited for a year:
Particulars ` in lakhs
Equity shares (`100 each) 100
8 % Debentures 150
10 % bonds 50
Reserves and surplus 200
Total assets 500
Assets turnover ratio 1.1
Effective tax rate 30 %
Operating margin 10 %
Required rate of return of investors 15 %
Dividend payout ratio 20 %
Current market price of share `13
You are required to –
(i) Draw income statement for the year.
(ii) Calculate the sustainable growth rate.
(iii) Calculate the fair price of the company’s share using dividend discount model.
(iv) Draw your opinion in the company’s share at current price.

MONEY MARKET INSTRUMENTS

(1) Call money – Call money is an amount borrowed or lent on demand for a very short period. The call money
is a part of the money market where day to day surplus funds, mostly of banks are traded. Moreover, the call
money market is most liquid of all short – term money market instruments. Call money or inter bank money
market is a segment of the money market where scheduled commercial banks lend on call or at short notice to
manage the day – to – day surplus and deficits in their cash flows.

(2) Treasury bills (T - Bill) –

 Issuer – Central bank or RBI
 Nature – Negotiable instrument
 Issue mechanism – Issued at discount and redeemable at par on maturity.
 Credit risk – Nil. Considered safest and most marketable instrument in the money market as bills are
issued by the RBI.
 Price risk – Low risk, as the tenure is short.
F−P 365
 Yield rate = x 100 x
P m
F = Face value
P = Issue price
m = Maturity period

(3) Certificate of deposits (CD) –

 Issuer – Banks and financial institution
  Maturity – Minimum 15 days and Maximum 12 months
 Amount – Minimum 1 lakh, beyond which in multiple of 1 lakh.
 Lock in period = Nil
 Nature - Negotiable instrument
 Issue mechanism – Issued at discount and redeemable at par on maturity
F−P 365
 Yield = x 100 x
P m

(4) Commercial paper –

 Issuer – Corporates, primary dealers and financial institution
 Maturity – Minimum 7 days and maximum 1 years
 Lock – in – period – Nil
 Nature – Negotiable instrument
 Issue mechanism – Issued at discount and redeemable at par
 Credit rating – Mandatory
 Buy – back – Issuer can buy back its own CP
F−P 365
 Yield = x 100 x
P m

Question: 12
AXY Ltd. is able to issue commercial paper of `50,00,000 every 4 months at a rate of 12.50 % p.a. The cost of
placement of commercial paper issue is `2,500 per issue. AXY Ltd. is required to maintain line of credit
`1,50,000 in bank balance. The applicable income tax rate for AXY Ltd. is 30 %. What is the cost of funds
(after tax) to AXY Ltd. for commercial paper issue? The maturity of commercial paper is four months.
[CA – May, 2014]

Question: 13
K Limited issued commercial paper as per following details:
Date of issue 19th October, 2010
Date of maturity 17th January, 2011
Interest rate 7.25 % per annum
Face value of commercial paper `10 crores
What was the net amount received by the company on issue of commercial paper?
[CS – June, 2007]
Question: 14
From the following particulars, calculate the effective interest p.a. as well as the total cost of funds to ABC
Ltd., which is planning a CP issue:
Issue price of commercial paper `97,350
Maturity period 3 months
Issue expenses: Brokerage 0.125 % for 3 months
Rating charges 0.50 % p.a.
Stamp duty 0.125 % for 3 months
[CA Final May 2006]
Question: 15
X Co. Ltd. issued commercial paper as per following detail:
Date of issue 17th January 1998
Date of maturity 17th April 1998
No. of days 90
Interest rate 11.25%
What was the net amount received by the company on issue of commercial paper?
[CA Final May 1998, CA Final June 2009 adapted]

Question: 16
M Ltd has to make a payment on 30the January, 2004 of ` 80 lakhs. It has surplus cash today, i.e. 31st October,
2003; and has decided to invest sufficient cash in a bank’s certificate of Deposit scheme offering on yield of
8% p.a. on simple interest basis. What is the amount to be invested now?
[CA Final Nov. 2003, CA Final Nov. 1998 adapted]

Question: 17
XYZ & Co plans to issue Commercial paper of `1,00,000 at a price of `97,000.
Maturity period – 3 months
Issue expenses are:
(i) Brokerage is 0.12 %
(ii) Rating charges is 0.50 % and stamp duty is 0.12 %.
What is the effective interest rate per annum and the cost of fund? [RTP – June 2009]

ADR AND GDR

Question: 26
Odessa Limited has proposed to expand its operations for which it requires funds of$ 15 million, net of issue
expenses which amount to 2% of the issue size. It proposed to raise the funds though a GDR issue. It considers
the following factors in pricing the issue:
(i) The expected domestic market price of the share is ` 300
(ii) 3 shares underly each GDR
(iii) Underlying shares are priced at 10% discount to the market price
(iv) Expected exchange rate is ` 60/$
You are required to compute the number of GDR's to be issued and cost of GDR to Odessa Limited, if 20%
dividend is expected to be paid with a growth rate of 20%.

CONCEPT OF FLAT RATE OF INTEREST

Under such a scheme finance companies structure their hire purchase loan on a flat rate whereby a quoted flat
interest rate is applied to the principal amount for the entire period of the contract and the aggregate of
principal and interest thus computed has to be repaid in equated installments in that period.

Total repayment including interest

EMI =
No .of monthly installments

How to calculate effective rate of interest:

n
Rate = x 2F
n+1
F = Flat rate

Question: 27 [CA – May, 2014]

GKL Ltd. is considering installment sale of LCD TV as a sales promotion strategy.In a deal of LCD TV, with
selling price of ` 50,000, a customer can purchase it for cash down payment of ` 10,000 and balance amount by
adopting any of the following options:
Tenure of monthly installments Equated monthly installment
12 `3,800
 24 `2,140
Required:
Estimate the flat and effective rate of interest for each alternative.
PVIFA 2.05%, 12 =10.5429 PVIFA2.10%, 12 =10.5107
PVIFA2.10%, 24 =18.7014 PVIFA2.12%, 24 =18.6593

Question: 28

Cost of car `2,40,000

Down payment `28,375
Period of loan 30 months
Flat rate of interest 6.497 %
Calculate EMI.