How to Calculate Sustainable Rate of Growth

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Calculating Sustainable Rate of Growth
Calculating Sustainable Rate of Growth (Image: calculator image by jedphoto from Fotolia.com)

Companies often experience growth, which is generally good for a company. However, a company must be able to grow at a rate that is feasible. If a company does not grow at a feasible rate, the company can see a decrease in value. A feasible growth rate is determined by calculating a firm's sustainable rate of growth. Management uses this figure to figure out how fast is too fast.

Determine the company's earnings retention rate. Earnings retention rate equals earnings after dividends divided by earnings. These numbers are available on a company's income statement. For example, Firm A had earnings of $1,000,000 and paid $100,000 in dividends. The earnings retention rate equals $900,000 divided by $1,000,000, which equals 0.9.

Determine the company's return on equity. Return on equity equals earnings divided by beginning shareholders' equity. Shareholders' equity is available on the company's balance sheet. For example, Firm A had a beginning shareholders' equity of $6,000,000. Therefore, $1,000,000 divided by $600,000 equals a return on equity of 0.167.

Multiply the earnings retention rate by return on equity to determine the sustainable rate of growth. In the example, 0.9 times 0.167 equals 0.1503, or Firm A can grow at 15.03 percent.

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