Question

You are given the following information for Clapton Guitars, Inc.

Profit margin		9%
Total asset turnover		1.3
Total debt ratio		0.3
Payout ratio		37%

Calculate the sustainable growth rate (in %) (round 4 decimal places)

Answer 1

First we will calculate the Return on assets (ROA) as per below:

Return on assets (ROA) = Profit margin * Total asset turnover

Putting the values in the above formula, we get,

Return on assets (ROA) = 9% * 1.3 = 11.7%

Now,

When total debt ratio (Debt / Total assets) is 0.3, so equity to total assets or equity ratio will be 0.7 (because if 30% of assets are financed by debt, then remaining 70% will be financed by equity).

Next, we will calculate Return on equity (ROE):

Return on equity (ROE) = Return on assets / Equity ratio

Return on equity (ROE) = 11.7% / 0.7 =16.7142857143

Now, we will calculate sustainable growth rate as per below:

Sustainable growth rate = Return on equity * (1 - payout ratio)

Sustainable growth rate = 16.7142857143% * (1 - 0.37)

Sustainable growth rate = 16.7142857143% * 0.63 =10.53%