Question

A firm has a retention ratio of 30 percent and a sustainable growth rate of 6.70 percent. The capital intensity ratio is 1.16 and the debt-equity ratio is .65. What is the profit margin?

Answer 1

SOLUTION

First we need to find Return on Equity (ROE)

Sustainable growth rate = ROE * Retention ratio

6.70% = ROE * 30%

ROE = 6.70% / 30%

ROE = 0.22333

Computation of profit margin ratio-

ROE = Profit margin * (1 / Capital intensity ratio) * Equity multiplier

ROE = Profit margin * (1 / Capital intensity ratio) * (1 + Debt equity ratio)

0.22333 = Profit margin * (1 / 1.16) * (1 + 0.65)

Profit margin = 0.22333 * 1.16 / 1.65

= 0.1570

= 15.70%