Valuation Tutorials

- Valuation Basics
- Enterprise Value
- Enterprise Value Formula
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- Market Capitalization
- Market Capitalization Formula
- Internal Growth Rate Formula
- Intrinsic Value Formula
- Absolute Valuation Formula
- Assessed Value vs Market Value
- Required Rate of Return Formula
- Historical Cost vs Fair Value
- Large Cap vs Small Cap
- Free Float Market Capitalization
- Market Cap vs Enterprise Value
- Book Value Vs Market Value
- Value vs Growth Stocks
- Book Value Per share
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- Discounted Cash Flows
- Going Concern concept
- Dividend Discount Model (DDM)
- Gordon Growth Model
- Gordon Growth Model Formula
- Discounted Cash Flow Analysis (DCF)
- DCF Formula (Discounted Cash Flow)
- Free Cash Flow Formula (FCF)
- Free Cash Flow to Firm (FCFF)
- Free Cash Flow to Equity (FCFE)
- Terminal Value
- Terminal Value Formula
- Cost of Equity
- Cost of Equity Formula
- Risk-Free Rate
- Sustainable Growth Rate Formula
- Beta in Finance
- Beta Formula
- CAPM Beta
- Stock Beta
- Calculate Beta Coefficient
- Unlevered Beta
- Market Risk Premium
- Market Risk Premium Formula
- Equity Risk Premium
- Risk Premium formula
- Weighted Average Cost of Capital (WACC)
- Cost of Capital Formula
- WACC Formula
- Security Market Line (SML)
- Systematic Risk vs Unsystematic risk
- Free Cash Flow (FCF)
- Free Cash Flow Yield (FCFY)
- Mistakes in DCF
- Treasury Stock Method
- CAPM Formula
- Cash Flow vs Free Cash Flow
- Business Risk vs Financial risk
- Business Risk
- Financial Risk

- Valuation Multiples
- Equity Value vs Enterprise Value
- Trading Multiples
- Comparable Company Analysis
- Transaction Multiples
- (Price Earning Ratio (P/E)
- PE Ratio formula
- PEG Ratio Formula
- Price to Cash Flow (P/CF)
- Price to Book Value Ratio (P/B)
- Price To Book Value formula
- Price Earning Growth Ratio (PEG)
- Trailing PE vs Forward PE
- Forward PE
- EV to EBITDA Multiple
- EV to EBIT Ratio
- EV to Sales Ratio
- EV to Assets

- Other Valuation Tools
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**Table of Contents**

## What is Internal Growth Rate Formula?

The internal growth rate is the rate of growth that the company can attain only with the help of its internal operation. This is the growth rate attained by the company without taking into effect the impact of any financial leverage in the form of debt funding. The formula for calculating the internal growth rate is a return on assets of the company multiplied by the retention ratio of the company. Return on assets for a company is calculated by the net income of the company divided by the total assets of the company.

Total assets include all the short term and long term assets of the company which the company acquires and deploys in order to run and expand its business operation. Retention ratio is the percentage of earnings that the company retains for its use and future growth of the company. Retention amount is the residual amount after the amount paid from earnings as a dividend.

Mathematically, Internal Growth Rate formula is represented as,

**Internal Growth Rate Formula = ROA * RR**

Where

- ROA= Return on Assets
- RR= Retention ratio

### Explanation of Internal Growth Rate Formula

This ratio signifies for a company that how much the company can grow sustainably in the future with the number of earnings it is generated with the help of the normal course of business. It is the operational growth rate, achieved without taking into consideration the borrowed funds in the form of debt by the company. That’s why this ratio is considered to be internal as this much the company will be able to grow even without taking any outside debt investments.

It is the growth achieved by a company with the help of the earnings it decides to retain after distributing the amount of money the shareholders in the form of a dividend. An analyst looking at internal growth rate ratio will look for a higher ratio as it signifies a better future prospect for the company.

### Examples of Internal Growth Rate Formula (with Excel Template)

Let’s see some simple to advanced examples to understand this ratio better.

#### Internal Growth Rate Formula – Example #1

Let us do the calculation of the internal growth rate for two arbitrary companies. For the calculation, we need a return on assets of a company and retention ratio which is calculated by deducting the dividend amount payable from the earnings of the company and dividing that numerator by net income available to the shareholders.

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Let’s assume some numbers in the table below for two companies.

For the calculation of internal growth rate formula first, calculate the following value,

**Retention Ratio for Company A**

- Retention Ratio (RR) = 1- (dividends paid/earnings)
- =1-(3/5)
- =0.40

**Retention Ratio for Company B**

- Retention Ratio (RR) =1-(3.5 / 6)
- =0.42

**Return of Assets for Company A**

- Return of Assets = $65/$140
- =46%

**Return of Assets for Company B**

- Return of Assets = $70/$155
- =45%

Therefore, the calculation of Internal growth rate for company A is as follows,

- IGR Formula = 46% * 0.40

**Internal Growth Rate for company A**

- IGR = 18.6%

**Internal growth rate for company B**

- IGR Formula = 45% * 0.42
- = 18.8%

We can see from the above example that the growth rate for the company B is higher than internal growth of the company A. This implies that the company B is able to grow through earnings from operations more than the company A. The internal growth does not take into account the effect of the growth from debt funding.

#### Internal Growth Rate Formula – Example #2

For the calculation of growth rate of Reliance Industries, we need a return on assets for the company and retention ratio which is calculated by deducting the dividend amount payable from the earnings of the company and dividing that numerator by net income available to the shareholders.

The table below depicts the dividend, earnings per share and the return on assets for reliance industries.

For the calculation of internal growth rate formula first, calculate the following value,

**Retention ratio**

- Retention ratio for Reliance Industries = 1- (6/56) =.89

Therefore, the calculation of growth rate of Reliance Industries is as follows,

- IGR Formula = 8% * 0.89

- IGR = 7.1%

Higher the growth rate better it is for the company, the ratio signifies for a company that who much the company can grow sustainably in the future with the amount of earnings it is generated with the help of normal course of business. The ratio for reliance industries signifies that reliance industries are able to grow by 7.1% with its internal operational income.

#### Internal Growth Rate Formula – Example #3

For the calculation of growth rate of TATA steel, we need a return on assets for the company and retention ratio which is calculated by deducting the dividend amount payable from the earnings of the company and dividing that numerator by net income available to the shareholders.

The table below depicts the dividend, earnings per share and the return on assets for Tata Steel.

For the calculation of internal growth rate formula first, calculate the following value,

**Retention Ratio for Tata Steel**

- Retention ratio = 1 – (9.4 / $75)
- =0.87

Therefore, the calculation of growth rate of Tata Steel is as follows,

- IGR Formula =13% * 0.87

**Internal growth rate of Tata Steel will be –**

- IGR = 11.4%

### Internal Growth Rate Calculator

You can use the following Internal Growth Rate Calculator.

ROA | |

RR | |

Internal Growth Rate Formula = | |

Internal Growth Rate Formula = | ROA x RR | |

0 x 0 = | 0 |

### Relevance and Use of Internal Growth Rate Formula

This ratio is very important to find out the future prospect of a company. Analysts who analyze the company keep a very close look at the ratio. The ratio is arrived at by using two very important parameters which the return on assets of the company. And the second variable used for calculating the internal growth rate is the retention ratio.

If a company is maintaining a higher level of retention ratio it signifies that the company has future growth prospect and is confident of generating a higher return with the money it is willing to retain. The internal growth is the rate that the company attains with the help of the earnings it decides to retain.

### Recommended Articles

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