The Sustainable Growth Rate

One ratio that is very helpful in financial analysis is called the sustainable development rate. It is the maximum rate of increase a firm can preserve without growing its financial leverage and using internal equity only. The accurate price of sustainable development can be calculated as

Sustainable growth rate = ROE * retention ratio

For the Timberland Company, ROE is 41 percent. The preservation ratio, had the Timberland Company compensated $6,100,000 in dividends, would be 95 percent, so we can calculate the sustainable development rate as

Sustainable growth rate = .41 * (.95) = 39%

The Timberland Company can enlarge at a maximum rate of 39 percent per year with no external equity financing or without growing financial leverage if it paid the dividend. As the Timberland Company's actual payment payout was zero, its actual sustainable increase rate is equal to its ROE of 41 percent.