Question

A firm wants a sustainable growth rate of 3.08 percent while maintaining a dividend payout ratio of 26 percent and a profit margin of 5 percent. The firm has a capital intensity ratio of 2. What is the debt-equity ratio that is required to achieve the firm's desired rate of growth? ο ο 74 times ο ο ο

Answer 1

Answer is “0.62 times”

Payout Ratio = 0.26

Retention Ratio = 1 - Payout Ratio
Retention Ratio = 1 - 0.26
Retention Ratio = 0.74

Capital Intensity Ratio = 1 / Total Asset Turnover
2.00 = 1 / Total Asset Turnover
Total Asset Turnover = 0.50

Sustainable Growth Rate = [ROE * Retention Ratio] / [1 - ROE * Retention Ratio]
0.0308 = [ROE * 0.74] / [1 - ROE * 0.74]
0.0308 - ROE * 0.022792 = ROE * 0.74
0.0308 = ROE * 0.762792
ROE = 0.04038

ROE = Profit Margin * Total Asset Turnover * Equity Multiplier
0.04038 = 0.05 * 0.50 * Equity Multiplier
Equity Multiplier = 1.62

Equity Multiplier = 1 + Debt-Equity Ratio
1.62 = 1 + Debt-Equity Ratio
Debt-Equity Ratio = 0.62 times