Could you please help me figure this question out? Thank you very much. A firm w

Question

Could you please help me figure this question out? Thank you very much.

A firm wishes to maintain a growth rate of 10 percent and a dividend payout ratio of 62 percent. The ratio of total assets to sales is constant at 0.9, and the profit margin is 9.6 percent. If the firm also wishes to maintain a constant debt-equity ratio, what must it be?

A firm wishes to maintain a growth rate of 10 percent and a dividend payout ratio of 62 percent. The ratio of total assets to sales is constant at 0.9, and the profit margin is 9.6 percent. If the firm also wishes to maintain a constant debt-equity ratio, what must it be?

Explanation / Answer

Answer: Calculation on the debt-equity ratio:

Retention ratio = 1 - 0.62 = 0.38

Sustainable growth rate = 0.10 = (ROE × 0.38)/[1 - (ROE × 0.38)];

ROE = 0.2392

Return on equity

= 0.2392 = 0.096 × (1/0.9) × (1 + D/E);

0.2392=0.1067*(1+D/E)

D/E = 1.242

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