Question

Fulkerson Manufacturing wishes to maintain a sustainable growth rate of 10 percent a year, a debt–equity ratio of .37, and a dividend payout ratio of 34 percent. The ratio of total assets to sales is constant at 1.38.
  
What profit margin must the firm achieve in order to meet its growth rate goal? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Profit margin             %

Answer 1

To find the profit margin, we can solve the DuPont identity. First, we need to find the retention ratio. The retention ratio for the company is:

b = 1 – Payout ratio

b = 1 – 0.34

b = 0.66

Now, we can use the sustainable growth rate equation to find the ROE. Doing so, we find:

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

0.10 = [ROE(0.66)] / [1 – ROE(0.66)]

ROE = 0.1377 OR 13.77%

Now, we can use the DuPont identity. We are given the total asset to sales ratio, which is the inverse of the total asset turnover, and the equity multiplier is one plus the debt–equity ratio. Solving the DuPont identity for the profit margin, we find:

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

0.1377 = (Profit margin)(1 / 1.38)(1 + 0.37)

Profit margin = 0.1387 or 13.87%