Question

Profit margin	=		9.9	%
Capital intensity ratio	=		.60
Debt−equity ratio	=		.75
Net income	=	$	110,000
Dividends	=	$	47,500

Based on the above information, calculate the sustainable growth rate for Southern Lights Co. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Sustainable growth rate             %

Answer 1

We need the return on equity to calculate the sustainable growth rate. To calculate return on equity, we need to realize that the total asset turnover is the inverse of the capital intensity ratio and the equity multiplier is one plus the debt−equity ratio. So, the return on equity is:

ROE = (Profit margin)(Total asset turnover)(Equity multiplier)

ROE = (.099)(1/.60)(1 + .75)

ROE = 0.2888 or 28.88%

Next we need the plowback ratio. The plowback ratio is one minus the payout ratio. We can calculate the payout ratio as the dividends divided by net income, sothe plowback ratio is:

b = 1 – ($47,500 / $110,000)

b = 0.57

Now, we can use the sustainable growth rate equation to find:

Sustainable growth rate = [(ROE)(b)] / [1 – (ROE)(b)]

Sustainable growth rate = [.2888(.57)] / [1 – .2888(.57)]

Sustainable growth rate = 0.1971 or 19.71%