A firm has decided that its optimal capital structure is 100% equity financed. I

Question

A firm has decided that its optimal capital structure is 100% equity financed. It perceives its optimal dividend policy to be a 45% payout ratio. Asset turnover is sales/assets = .8, the profit margin is 10%, and the firm has a target growth rate of 9%.

Calculate the sustainable growth rate. (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

If not, what should the asset turnover be to achieve its goals? (Do not round intermediate calculations. Round your answer to 3 decimal places.

Instead, what would the profit margin need to be to achieve its goals? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

A firm has decided that its optimal capital structure is 100% equity financed. It perceives its optimal dividend policy to be a 45% payout ratio. Asset turnover is sales/assets = .8, the profit margin is 10%, and the firm has a target growth rate of 9%.

Explanation / Answer

a1- Sustainable growth rate = g = ROE* retention ratio

The ROE as per Du-pont formula =NPM * TATR * EM

where NPM = net profit margin = 10% = 0.1

TATR = total asset turnover ratio = 0.8

EM = Equity multiplier = 1 + D/E, Since D =0, EM = 1+ 0 = 1

Hence ROE = 0.1*0.8*1 = 0.08

Hence g = 0.08* (1-payout ) = 0.08*(1-0.45) = 0.044 = 4.4%

Sustainable growth rate = 4.4%

a-2 Is the firm’s target growth rate consistent with its other goals? - NO

Since the traget growth rate is 9% and sustainablble growth rate is only 4.4%

b. In order to acheive the target growth rate of 9%, the ROE should be = 0.09/0.55 = 0.163636

So the asset turnover should be= 0.163636/0.1 = 1.636

c. In order to acheive the target growth rate of 9%, the ROE should be = 0.09/0.55 = 0.163636

So the profit margin should be= 0.163636/0.8 = 0.2

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