Question

McCormac Co. wishes to maintain a growth rate of 6 percent a year, a debt-equity ratio of 0.37, and a dividend payout ratio of 66 percent. The ratio of total assets to sales is constant at 1.33. Required: What profit margin must the firm achieve? (Do not round your intermediate calculations.) rev: 09_17_2012 Multiple Choice 4.71% 16.41% 16.16% 9.24% 8.43%

Answer 1

We have all the variables to calculate ROE using the DuPont identity except the profit margin. If we find ROE, we can solve the DuPont identity for profit margin. We can calculate ROE from the sustainable growth rate equation. For this equation we need the retention ratio, so:

b = 1 - 0.66

b = 0.34

Using the sustainable growth rate equation and solving for ROE, we get:

Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

0.06 = [ROE(0.34)] / [1 – ROE(0.34)]

ROE = 0.1665 or 16.65%

Now we can use the DuPont identity to find the profit margin as:

ROE = PM(TAT)(EM)

0.1665 = PM(1 / 1.33)(1 + 0.37)

PM = (0.1665) / [(1 / 1.33)(2.37)]

PM = 9.34%