Question

Assume the following ratios are constant:

Total asset turnover		2.70
Profit margin		6.7	%
Equity multiplier		2.00
Payout ratio		22	%

What is the sustainable growth rate?

Answer 1

Step-1, Calculation of Return on Equity (ROE)

As per DuPont Model, the Return on Equity (ROE) = Net Profit Margin x Total Asset Turnover x Equity Multiplier

= 6.70% x 2.70 Time x 2.00

= 36.18%

Step-2, Calculation of Sustainable Growth Rate

Sustainable Growth Rate = [ROE x (1-Dividend Pay-out ratio)] / 1- [ROE x (1-Dividend Pay-out Ratio)] x 100

= [0.3618 x (1 – 0.22)] / [1 – {0.3618 x (1 - 0.22)}]

= [0.3618 x 0.78] / [1 – (0.3618 x 0.78)]

= 0.2822 / [1 – 0.2822]

= 0.2822 / 0.7178

= 0.3932 or

= 39.32%

“Hence, the Sustainable Growth Rate will be 39.32%”