General Systems is a firm that manufactures personal computers. As a top manager in the firm, you are considering changes in the way the firm is run. Currently, the firm has after-tax operating income of $50 million on capital invested of $250 million (at the beginning of the year). The firm also reinvests $25 million in net capital expenditures and working capital.
a. Estimate the expected growth rate in earnings, given the firm’s current return on capital and reinvestment rate.
b. Holding the return on capital constant, what would happen to the expected growth rate if the firm increased its reinvestment rate to 80%?
c. What would the effect on growth be, if as the reinvestment rate increases to 80%, the return on capital on investments drops by 5%? (For instance, if the return on capital is currently 18%, it will drop to 13%.)
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