Question

You are given the following information on Kaleb's Heavy Equipment: |

Profit margin | 5.1 | % | ||

Capital intensity ratio | .60 | |||

Debt-equity ratio | .6 | |||

Net income | $ | 50,000 | ||

Dividends | $ | 13,200 | ||

Calculate the sustainable growth rate. |

Answer #1

**Substantial growth rate = 11.12%**

**Explanation:**

Step 1) Computation of plowback ratio

Dividends = $13,200

Net Income = $50,000

Plowback ratio (b) = 1 - (Dividend / Net Income)

Plowback ratio (b) = 1 - ($13,200 / $50,000)

Plowback ratio (b) = 0.736

.

Step 2: Computation of Return on Equity.

Profit Margin = 5.10%

Capital Intensity ratio = 0.60

Debt equity ratio = 0.6

Asset turnover ratio = 1 / capital intensity ratio = 1 / 0.60 = 1.666667

Equity multiplier = 1 + Debt equity ratio = 1 + 0.6 = 1.60

Return on Equity = Profit Margin * Total Assets Turnover * Equity multiplier

Return on Equity = 0.0510 * 1.666667 * 1.60 = 0.136 or 13.60%

Return on Equity = 13.60%.

.

Computation of substantial growth rate.

Substantial growth rate = (ROE * b) / [1 - (ROE * b)]

Substantial growth rate = (0.136 * 0.736) / [1 - (0.136 * 0.736)]

Substantial growth rate = 0.100096 / [1 - 0.100096] = 0.100096 / 0.899904

Substantial growth rate = 0.1112 or

**Substantial growth rate = 11.12%**

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