QUESTION 4b [ 7 marks]

Review the example presented in Hogan et al. (2004:257) and answer the question below.

TABLE 8.5 Asset growth models Bank situation Average total assets $500 000 000 Average equity capital $34 000 000 Expected net profit margin 8.50% Expected yield on average total assets 12.00% Expected return on average total assets 1.02% Leverage multiplier 14.71x Expected return on average equity capital 15.00% Cash dividend payout percentage 40.00% Planned asset growth rate 12.00% The annual growth rate in assets that can be supported by internally generated equity capital is called the sustainable growth rate (SG). This rate can be determined from the following equation: SG = (ROA) (1 - D) EC/TA-(ROA)(1 - D) where SG = sustainable growth rate, or the annual rate of increase in average total assets that can be supported by internally generated equity capital PM = profit margin, or net revenue after taxes divided by total operating income AY = asset yield, or total operating revenue divided by average total assets D . percentage of after-tax net revenue paid in cash dividends EC - average equity capital TA - average total assets LM = leverage multiplier, or average total assets divided by average equity capital ROA = return on average total assets, or net revenue after taxes divided by average total assets ROE = return on average equity capital, or net revenue after taxes divided by average equity capital. Solving for SC: SG = (0.0102)(1 -0.40) 0.068 - (0.0102)(1 - 0.40) = 9.89% Alternatively, the projected capital ratio (PCR) may be calculated by assuming that the only source of additional capital is internally generated equity capital from retained profits. This ratio can be determined from the following equation: PCR = EC + TA(1 + AGR)(ROA)(1 -D) TA(1 + AGR) where PCR = projected capital ratio when retained profits is the only source of additional capital AGR = planned asset growth rate. Solving for PCR: PCR 34 + 500(1 + 0.12)(0.0102)(1 -0.40) 500(1 + 0.12) 34+3.4272 560 CHAPTER 8 6.68% 257