This is part of the Higgins textbook summary that will help you to follow FM422 Corporate Finance. You can allocate your time on other stuffs rather than summarising the book. THIS IS NOT VERY COMPLETE AND I SUGGEST YOU READ THE TEXTBOOK FURTHER. However, I AM ABLE TO SUMMARISE THE TEXTBOOK FOR YOU...
MANAGING GROWTH
Many executives see growth as something to be maximized because as
growth increases, the frmms market share and profts should be
maximized.
o Sales growth is not something that should be maximized.
However, from a fnancial perspective, growth is not always a blessing.
o Rapid growth can put considerable strain on a company’s
resources, and if not controlled, it can lead to bankruptcy.
o However, slow growth is not good as well since they will come
under increasing pressure from shareholders, irate board members,
and potential raiders.
Sustainable growth rate is the maximum rate at which company
sales can increase without depleting fnancial resources.
From the assumption, when we want to increase sales, we need to raise
assets. And to pay for the increase in assets must come from retained
earnings (assumption 2) and debt.
So, continuing from the written notes in page 1,
o g¿ =PRA T ^
o PA is the operating performance of the business
o R captures managementms attitude toward the distribution of
dividends
o T^ reflects its policies regarding fnancial leverage.
So, the sustainable growth rate is the only growth rate in sales that is
consistent with stable values of the four ratios.
If a company grows exceeding the sustainable growth rate, then it had
better improve operations (increase its P or A) or alter its fnancial policies
(increase retention rate or increase fnancial leverage).
Sustainable growth rate varies linearly with ROA (PA) or operating
performance, given stable fnancial policies ( R T ^ ).
WHAT TO DO WHEN GROWTH EXCEEDS SUSTAINABLE GROWTH RATE
If it only happens for a short period of time, then further borrowing can
solve the problem (only for short term).
In the long term:
o Sell new equity
o Increase fnancial leverage
o Reduce the dividend payout
o Prune away marginal activities
o Outsource some or all of production
o Increase price
o Merge with cash cow.
1. Sell New Equity
If a company is willing and able to raise new equity by selling shares, its
sustainable growth rate will rise and the problem is gone. The increased
equity, plus whatever added borrowing it makes possible, will become
sources of cash with which to fnance further growth.
However, the problem with this is that some companies might be unable to
do so and some are not attracted to issue new equities.
o Unable because they may be in countries with less-developed stock
markets causing it to be hard to sell new equities. Even in well-
developed, unless the product is really good, itms really hard to fnd
venture capital to fnance it or fnd investment banker to help them
sell the shares to other investors.
2. Increase Leverage
Can lead to bankruptcy.
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