A firm wishes to maintain a growth rate of 10 percent and a dividend payout rati

Question

A firm wishes to maintain a growth rate of 10 percent and a dividend payout ratio of 58 percent. The ratio of total assets to sales is constant at 1, and the profit margin is 9.6 percent. If the firm also wishes to maintain a constant debt-equity ratio, what must it be? (Do not round your intermediate calculations.)

A firm wishes to maintain a growth rate of 10 percent and a dividend payout ratio of 58 percent. The ratio of total assets to sales is constant at 1, and the profit margin is 9.6 percent. If the firm also wishes to maintain a constant debt-equity ratio, what must it be? (Do not round your intermediate calculations.)

Explanation / Answer

Growth rate = 10%

Payout ratio = 58%

Retention ratio = 42%

Return on equity = Growth rate / Retention ratio

                            = 10% / 42%

                            = 23.81%

Assets turnover ratio = 1

Profit margin = 9.6%

Return on equity is calculated below using Du Pont Formula:

23.81% = (Total assets / total equity) × Assets turnover × Profit margin

             = (Total assets / total equity) × 1 × 9.6%

(Total assets / total equity)    = 2.48

(Debt + equity) / Equity = 2.48

Debt / equity = 1.48

Hence, Debt equity ratio is 1.48

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