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Review questions

Mathematical formula


g – Sustainable growth rate

ROIC – Return on invested capital after tax (based on the beginning of the year balance sheet)

NBC – Net borrowing cost measured as a percentage (based on the beginning of year balance sheet)

NIBL – Net interest-bearing liabilities (based on the beginning of year balance sheet), which is equal to net financing assets and liabilities

E – Equity (based on the beginning of year balance sheet)

PO – Payout ratio (dividend as a percentage of net profit)

The sustainable growth rate informs about how fast a firm can grow while preserving its financial risk; i.e. maintaining the financial leverage at the same level despite growth.

ROIC, NBC, financial leverage and the payout ratio.

False – a positive sustainable growth rate indicates that a firm reinvest some of its earnings in its business. This is only attractive for shareholders if these investments generate a return which exceeds the cost of capital.

Growth is only attractive if it adds value. Growth in Economic Value Added (EVA) ensures that growth is associated with value creation

False – growth based on recurring items is more sustainable in nature than growth based on non-recurring items.

EPS does not take into account investments and risk. Thus, growth in EPS may be negatively correlated with value creation.

No – share buybacks only adds to EPS if ROIC exceeds net borrowing costs (NBC)

Growth is typically associated with investments in inventories, accounts receivable and property, plant equipment and intangible assets. Thus, the more ‘asset heavy’ a business is the more likely it is that growth affects the liquidity negatively.