Introduction to Finance

2. Cost of capital is included in the calculation of economic value added, a measure of 
fi rm performance developed by Stern Stewart & Company. Stern Stewart’s website, 
http://www.sternstewart.com, contains information on the importance of the cost of 
capital as well as practitioner-oriented research reports.
18.5
Planning Growth Rates
A fi rm’s growth is partly determined by management’s strategy to acquire or maintain market 
share in a growing or stable market. But management’s plans for future sales, asset, and fi nan-
cing growth may not happen because of the competitive struggle in the marketplace. Growth that 
is faster or slower than expected may occur. A simple fi nancial planning tool, the internal growth 
rate model, is available to determine how quickly a fi rm can grow without running short of cash.
Internal Growth Rate
The 
internal growth rate
measures how quickly a fi rm can increase its asset base over the 
next year without raising outside funds. It does not measure divisional growth or break down 
total growth into domestic or international components. The internal growth rate gives a gen-
eral, company-wide value.
It is equal to the ratio of the expected increase in retained earnings over the next year to 
the current asset base, as follows:
Expected change in retained earnings
Total assets
internal growth rate 
a measure 
of how quickly a fi rm can increase 
its asset base over the next year 
without raising outside funds
0
10
20
30
40
P
ercent
50
70
60
80
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
2015
2013 2014
Consolidated Edison
AT&T 
Sears
Apple
Microsoft
Walgreens
Google
ExxonMobil
McDonald’s
Amazon
Wal-Mart
Long-term Debt Divided by Total Assets