Question

A firm wants a sustainable growth rate of 2.83 percent while mainaining a dividend payout ratio of 21 percent and a profit margin of 5 percent. the firm has a capital intensity ratio of 2. what is the debt equity ratio that is required to achieve the firms desired rate of growth?

Answer #1

Sustainable Growth Rate = 2.83 % and Dividend Payout Ratio = 21 %

Growth Rate = ROE (Return on Equity) x (1-Dividend Payout Ratio) = ROE X (1-0.21) = 2.83

ROE = 2.83 / (1-0.21) = 3.582 %

Capital Intensity Ratio = 2 = Total Assets / Sales and Net Profit Margin = 5 %

Therefore, as per the DuPont Formula:

ROE = Profit Margin x [1/Capital Intensity Ratio] x [Equity Multiplier] = 5 x (1/2) x (Total Assets / Equity) = 3.582 (Equity Multiplier = Total Assets / Equity)

Total Assets / Equity = (3.582 / 2.5) = 1.4329

(Debt + Equity) / Equity = 1.4329

Debt / Equity = 1.4329 - 1 = 0.4329 ~ 0.433

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