Question

Sig, Inc., wishes to maintain a growth rate of 12 percent per year and a debt-equity ratio of .43. The profit margin is 5.9 percent, and the ratio of total assets to sales is constant at 1.80. What dividend payout ratio is necessary to achieve this growth rate under these constraints?

Answer 1

Equity Multiplier = 1 + Debt-equity Ratio
Equity Multiplier = 1 + 0.43
Equity Multiplier = 1.43

Total Assets Turnover = 1 / Ratio of Total assets to sales
Total Assets Turnover = 1 / 1.80

Return on Equity = Profit Margin * Total Assets Turnover * Equity Multiplier
Return on Equity = 5.90% * 0.5556 * (1/1.80)
Return on Equity = 4.6872%

Let retention ratio be “b”

Growth Rate = [ROE * b] / [1 - ROE * b]
0.12 = [0.046872 * b] / [1 - 0.046872 * b]
0.12 - 0.005625 * b = 0.046872 * b
0.12 = 0.052497 * b
2.29 = b

Retention Ratio = 1 - Payout Ratio
2.29 = 1 - Payout Ratio
Payout Ratio = -1.29 or -129%